Insurance Law: Cases and Materials 9781509955534, 9781841132747

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For Allen Ward Rawlings George Leonard Lowry

Preface This book complements our earlier work, Insurance Law: Doctrines and Principles (Oxford, Hart, 1999). The structure follows the contract of insurance from its inception through its formation and concluding with claims. A distinctive feature is that we draw materials, including cases and legislation, from other common law jurisdictions as a means of illustrating how problems that have long confronted the UK judiciary and legislature have attracted different responses elsewhere. While the book is not systematically comparative in approach, it does have a comparative component. In writing and compiling this work the authors have incurred debts to various colleagues, particularly Loukas Mistelis, Rod Edmunds of Queen Mary, and Michael Bridge of UCL. We also owe a debt of gratitude to John Birds, Malcolm Clarke and Rob Merkin for their help and encouragement along the way. We are most grateful to authors and owners of copyright materials for their kind co-operation. Needless to say, we thank Richard Hart and all at Hart Publishing for their support and patience. We have endeavoured to state the law as it stood in October 2003. John Lowry and Philip Rawlings St Albert’s Day, 2003 Roy Goode House, London

1 The Insurance Contract 1.1 Introduction At its root, an insurance contract is a means by which the risk of loss is shifted from the person who otherwise might suffer on to an insurer and, through the insurer, on to other insureds. It is true that an important part of life insurance business is concerned with investment, but even there the element of riskshifting will be present (eg see [114]). Of course, the skilful insurer is able to persuade people that they should not bear the risks to which they are subject, and is able also to calculate matters so as to take in more income in premiums than is paid out in claims (although in reality the picture is rather more complex than this since insurers earn income by investing premiums and they cover part of their potential liabilities by reinsurance). The insurance contract contemplates, therefore, the possibility, not just that the insurer will become liable to the insured, but also that the insurer will never become so liable. In other words, this is an unusual sort of contract in that it requires performance by one party — the

insured — in the shape of the payment of a premium, while the other party — the insurer — is only required to promise to perform if a loss is sustained that comes within the terms of the policy.

1.2 Risk [101] F Ewald (trans J-M Dautrey and CF Stifler), “Risk in Contemporary Society” (2000) 6 Connecticut Insurance Law Journal 365 [footnotes omitted] ‘THE SOCIAL PERCEPTION OF RISK’ This is the domain of insurance. Here, risk pertains to a future event, one that may also be possible, probable, contingent, fortunate or unfortunate. In any case, one that is feared for its possible consequences to property. In this realm, risk is always potential. However, insurance gives a current value to risk and ascribes it a cost — an insurance premium or fee. Thus, with regard to insurance, risk remains within the confines of monetary valuation. In fact, insurance risk is nothing but the assessment of a value. Insurance is what gives a price to risk in the economic sense, a monetary value, which is really what quantifies value.

How does one establish the cost of risk? Two theories apply. Under the first one, of a largely psychological nature, the cost of risk is measured by the aversion to risk of the individual who wishes to avoid it. In this case, quantification is not required. The cost of risk is the total premium agreed upon between the individual who wishes to transfer it and

the one who agrees to assume it. The following anecdote illustrates this point. In an effort to promote his whisky, the president of the Cutty Sark distillery had offered a large monetary sum to the first person to see the Loch Ness Monster. It may be that one night he had a nightmare or suffered remorse, but he would have to keep his foolish promise none the less, which would undoubtedly endanger his company’s financial well-being. He therefore hastened to find an insurer, someone to whom he could transfer the risk he had taken so brashly. And he found one, Lloyd’s of London, with which he agreed on a premium. The coverage of this unsurpassable, potential, and exceptional risk involved a cost — a risk transfer. There was insurance without any need to quantify. The concept of insurance risk is not so much tied to the notion of danger as it is to that of expectation or fear. Risk is the measure of an expectation — a mathematical expectation that, according to Pascal, is the product of the probability of the event multiplied by its value. A moral expectation…which relates to what I am willing to and what I ought to pay, in terms of mathematical expectation in order to avoid risk. The “additional cost” would measure exactly what the value of the risk is for me. In the words of Michel Albert who initially made the distinction, this purely contractual vision of insurance corresponds to a more “maritime” than “riparian” view of insurance. In continental Europe, France in particular, one views insurance as tied to the concept of mutuality, or as a function of statistics and probability. This view stems from the fact that, in

France, insurance had to set itself apart from gambling and betting to be recognised. It follows that risk reflects the probability that an event will take place in a given population. Consider the population of French drivers, the road conditions, and the number of cars on the road. There are currently about 8,000 annual road deaths. In the words of the wellknown sociologist Adolphe Quetelet, these deaths represent the “budget” that the French population commits to road travel each year. One can anticipate that, all things being equal, this figure will remain constant from year to year, within a few standard deviations. The average premium per inhabitant or per driver can then be established. At the same time, it is possible to assess the chance that any one individual has of being among the 8,000 victims. This chance is a function of a car’s power, a driver’s experience, the places where he drives and so forth, and these criteria are used to calculate an individual’s insurance premium. Indeed, not everyone represents the same risk to the group. Some individuals drive less carefully than others. This is another way of establishing the cost of risk; it corresponds to the greater or lesser probability of incurring an accident in relation to the average. This cost is called the equitable cost. Under this second analysis (more sociological than psychological) the group outweighs the individual. Risk influences the group. It affects it with depressing regularity and affects every individual as members of the group. Risk has a defining and unifying effect on the group and gives it a personality and an identity.

This is the paradox of freedom: each member can feel as free as he will; through his actions he will contribute in one way or another to reproducing the common statistics. Such a group, identified on the basis of its risk, is what is called a mutuality. By assessing the cost of risk so that it can become the subject of a contract, insurance gives existence to non-existence, immediacy to the non-current, and form to potential. It inverts the course of time. The feared event exists whereas it has not taken place and may in fact never take place. Risk exists, materialised through a contract, in the form of an infinitesimal fraction of what it will become. That is, it exists in such a manner that its presence, while thoroughly real, remains almost imperceptible. This is what makes insurance doubly effective. The fragmentation of that risk renders feared events no longer feared. Insurance eradicates and decimates adversity. It makes these fears more bearable. Sometimes too much so. But the merit of insurance extends beyond what would otherwise closely amount to a public-aid dynamic. It transforms the perception of events in such a way so that not to carry insurance becomes a fault. This point was well illustrated last century by Edmond About in his booklet insurance [L’Assurance (1865)]: As you know, as the wheels of horse-drawn carriages wear out on cobbles, they shed more than 20 kilos of iron every day on the streets of Paris. These 20 kilos of precious metal are not completely destroyed but they are lost. If you will,

their infinitesimal division makes them useless by dint of making them irretrievable. Suppose that a patient and ingenious worker manages, however, to pick up these atoms of iron, restore their cohesion, resistance and all useful qualities. Further suppose that he forges thern into a lever. Will he not have created capital for individuals to use? A centime is no more capital than a wisp of iron is a lever. It has barely any value. You will find very few individuals who are sensitive to the loss or gain of a centime because a single centime amounts to nothing. But he who would obtain by honest means this useless centime from his fellow citizens would create a capital of 10 million centimes; that is, a nice lever for moving mountains.

The merit of insurance ensues from pricing expectation and giving reality to potentiality so that any individual who does not account for the possibility of risk in his conduct becomes a factor of individual and collective loss. An individual loss with regard to what his situation will be if the risk becomes real; a collective one as he deprives society of the power to move mountains. Insurance owes its economic effectiveness to solidarity. As it turns potential events into reality, insurance becomes the mechanism by which a possible loss transforms itself into capital. It is simultaneously a combination of protection and an economic mechanism that inverts symbols and turns a loss into a principle of yield. Its value lies in its being much more than a simple mechanism of allocation of liability. Insurance suggests a social experience of risk to both liberalism and democracy. To the former because liberalism is a political philosophy that

advocates risk management as a principle of government. Individuals must face risk in order to become truly aware of their real identity; finding resources in themselves in the form of foresight and, in others, in the form of voluntary association. But insurance, at least in its practical form, is also the product of democracy to which it gives its image of solidarity. Thus, for two centuries, insurance has continuously prompted us to be aware of ourselves both individually and collectively. As the Baron de Beauverger said in 1868 during a parliamentary debate on industrial accidents: “As a system, our society is nothing but an all encompassing insurance, insurance against weaknesses, insurance against misfortune, insurance against ignorance. Look at institutions through that prism and you will see that they all seek the same goal, a noble and generous goal.” This analysis of risk was seriously undermined when an attempt was made to make insurance resolve social problems linked to the development of an industrial society. With the rise of social insurance, insuring oneself becomes mandatory…It is a matter of seeing to it that individuals are protected against certain risks of a welfare nature. The concept is twofold: regardless of his income, every individual must be protected from these risks since such risks are not equally allocated throughout society…. If there are social risks, it is because society itself generates them as it develops without regard to a fair allocation. Compensating for inequalities in the face of risks, establishing equalities in the face of

opportunities…. Social insurance makes coverage against social risks no longer an act, but an entitlement. It is first a salaried worker’s entitlement, and the institution of social security makes it a citizen’s entitlement. The actualisation of the potential, of which the economic translation is capitalisation, gives way to a sort of generalised assistance based on allocation. This rationale regarding insurance became extremely widespread. Today, welfare outlays in the nation of France exceed the budget of the state of France. And the gap continues to widen in accordance with a rationale under which the nature of covered risks (health and retirement) hardly suggests a shift. Yet, the limit beyond which welfare outlays seem destined to ruin their own sources of supply has been reached: social costs are exhausting the economy. The economic rationale couples with a moral rationale: instead of creating an incentive to take risks, health and welfare services engender phenomena of “demoralization” that are counterproductive. Insurance no longer operates as an incentive to take risks, indeed, it directs us to never have to take any. We have considered some of the issues regarding the necessary limit to risk-taking and the danger of excessive risk-taking. We now find ourselves facing an inverse situation: what we may fear is not excessive risk-taking, but, on the contrary, the absence thereof. Once again, there arises an issue of balance.

THE LEGAL PERCEPTION OF RISK …In an industrial society, it is believed that there can be no risk-free activity, or business…. Risk is inevitable and beyond debate; the only issue therefore is the allocation of its cost. The issue is not to inflict a penalty, but to determine who, between the one who caused the risk and the one who suffered from it, must bear the cost. Penal considerations are irrelevant; only social considerations come into play. It is not property speaking an issue of liability but an issue of risks: who must bear the risks? Reason and legal fairness dictate that it must be borne by the individual who by virtue of his actions has assumed the consequences of his deed and activity. [R Saleilles, Les Accidents du Travail et La Responsabilité Civile (1897)]

It is inconceivable to require that, as a condition of acceptance, an activity or a business must be free from risk to others. There is none the less a condition. The burden must not be borne by those individuals who are subjected to the risks, those who impose such risks must bear their costs. Rules governing liability regulate such transfers on the basis of risk, hence the existence of objective liability and presumptions of liability whose rationale lies in placing the burden of risk on the individual who creates or profits from it. Thus, the response to risk is indemnification rather than prevention. In other words, insurance has developed considerably with the multiplication of required liability coverage (there are about a hundred of them in France). Until recently, nobody was concerned about this new

social contract the contract of solidarity according to which, risk is acceptable so long as it is indemnified and its cost not borne by the victim. Today, we are witnessing a remarkable shift in this pattern. The issue is no longer so much that of multiplying risk liabilities and structuring through insurance the solvency of those liable as it is to prevent certain risks from being taken. Not only is prevention outpacing indemnification, but efforts are also made to avert risks that have not yet been recognised. Precaution governs. Several factors account for these recent developments. First, damages no longer pertain to individual accidents as much as they pertain to catastrophes. The amounts currently involved exceed the limits of what can be insured as well as indemnified. Secondly, the cost of liability is also being reevaluated. The First World War provides a good scale by which to weigh this new method of measuring risk. During the war, a general could send 300,000 men every two weeks off to be killed, as was the case during the Chemin des Dames battle. Today, only “zero-risk” wars can be waged. A peculiar transmutation of values, indeed! Under the traditional cost-benefit analysis, it was enough that advantages outweighed risks to feel justified in taking risks and thus in accepting a portion of loss. Today, risk tends to be measured on the basis of the loss portion: what justifies the sacrifice? Do not those unfortunate enough to make up the loss portion count as much as others? Such is the method of valuation underlying the zero-risk problematic.

The rationale of precaution does not advocate, as it has been said, a change of focus from risk to fault. It results from a twofold reassessment of risk. First, it results from the technological powers that are now at work and over which we know we fail to exercise full control. We are witnessing an excess of might over power that we do not really know how to express from a legal standpoint. It can be characterised as a developmental risk, principle of precaution depending on whether we look at it from a legal or political standpoint. Secondly, the rationale of precaution results from a sort of backlash of victims who no longer accept the cynicism arising from the traditional formula for the acceptance of liability. What they challenge is not so much the amount of damages as the imbalance of power linked to technological risks. And, today, as a result of this backlash, liability tends to be assessed on the basis of what was hitherto considered negligible. Here again is another case of how the experience of risk has its limits. Given the inordinate power now in existence (which can be measured by the fact that we cannot measure its effects), the relations of asymmetry and dependence (with the sense of a loss of autonomy that ensues), and the magnitude of the risks created, should it be appropriate, short of putting an end to the process, at least to take a pause that would allow us to regain control over the changes governing us? Time for precaution is time for moratoria. CONCLUSION

…The purpose [of this paper] was not to consider every experience of risk. The intent was solely to understand how risk could be at the core of contemporary society. Not simply because of the threats hovering over us, but more importantly, as a general principle of valuation. By seeking the value of values through risk, contemporary society found itself inexorably subjected to the dialectic of risk. The morality of risk, while encouraging sacrifice, sets it as its limit. The perception of risk constitutes a defining experience for contemporary society: how far is too far? While valuing risk, adventure and entrepreneurship, contemporary society seeks to keep it within measure. Thus, while risk stands as a principle of valuation, motivation, and action, it also constitutes a principle of limitation, restriction, and prohibition. When overvalued or undervalued, risk quickly turns human experiences into inhuman ones. There is therefore no need to set a morality of risk against a morality of protection. Indeed, the morality of risk is inextricably a morality of protection. Risk and safety are not opposite concepts independent from each other, Risk both affirms and negates. It arises from the need to surpass oneself, from the necessity to transcend the accepted frontier and also from the pressing awareness of the danger of going beyond the limit. This is precisely why, by taking on risks, individuals in contemporary society have set the conditions for feeling perpetually restless, better still, have dedicated themselves to anxiety and responsibility.

1.3 General Definition of Insurance Since those who conduct insurance business are subject to regulation (see chapter 2) and insurance contracts involve rights and obligations not generally present in other forms of contract (such as the duty of disclosure, see chapter 4), it might seem to be of fundamental importance to have a clear definition of ‘insurance’. Unfortunately, its meaning remains obscure, and, with some exceptions, judges and legislators have been reluctant to attempt a definition. [102] Lucena v Craufurd (1802) 2 B & P (NR) 269 Lawrence J: Insurance is a contract by which the one party in consideration of a price paid to him adequate to the risk, becomes security to the other that he shall not suffer loss, damage, or prejudice by the happening of the perils specified to certain things which may be exposed to them.’

[103] Prudential Insurance Co v Commissioners of Inland Revenue [1906] 2 KB 658 Channell J: ‘Where you insure a ship or a house you cannot insure that the ship shall not be lost or the house burnt, but what you do insure is that a sum of money shall be paid upon the happening of a certain event. That I think is the first requirement in a contract of insurance. It must be a contract

whereby for some consideration, usually but not necessarily for periodical payments called premiums, you secure to yourself some benefit, usually but not necessarily the payment of a sum of money, upon the happening of some event. Then the next thing that is necessary is that the event should be one which involves some amount of uncertainty. There must be either uncertainty whether the event will ever happen or not, or if the event is one which must happen at some time there must be uncertainty as to the time at which it will happen. The remaining essential is that which was referred to by the Attorney-General when he said the insurance must be against something. A contract which would otherwise be a mere wager may become an insurance by reason of the assured having an interest in the subject-matter — that is to say, the uncertain event which is necessary to make the contract amount to an insurance must be an event which is prima facie adverse to the interest of the assured. The insurance is to provide for the payment of a sum of money to meet a loss or detriment which will or may be suffered upon the happening of the event. By statute it is necessary that at the time of the making of the contract there should be an insurable interest in the assured. It is true that in the case of life insurance it is not necessary that the interest should continue, and the interest is not the measure of the amount recoverable as in the case of a fire or marine policy. Still, the necessity of there being an insurable interest at the time of the making of the contract shows that it is essential to the idea of a contract of insurance that the event upon which the money is to be paid shall prima facie be an adverse event. Thus a contract depending upon the dropping of a life, such as a contract whereby two or more people purchase a property as joint tenants with the object of the longest liver getting the benefit of survivorship, would not be a contract of life insurance, although it would be a contract with reference to a contingency depending upon a life or lives; it would not be

a contract of insurance at all. A contract of insurance, then, must be a contract for the payment of a sum of money, or for some corresponding benefit such as the rebuilding of a house or the repairing of a ship, to become due on the happening of an event, which event must have some amount of uncertainty about it, and must be of a character more or less adverse to the interest of the person effecting the insurance. Then does the particular contract with which we have here to deal come within that definition of a contract of insurance? The contract is to pay a sum of 95l. if the person insured attains the age of sixty-five, and 30l. if he dies under that age. It seems to me that for the purpose of determining whether that contract comes within the definition we must look at it as a whole, and not split it up into two separate parts. If it were to be so split up, and treated as two separate contracts, I should incline to the view that even the old age endowment portion of it—that is to say, the contract to pay the sum of 95l.—would satisfy the definition. In the first place, the event on which the money is to be paid is uncertain, for it is uncertain whether the assured will live to the age of sixty-five, and whether consequently the money will be payable at all. Secondly, it seems to me that the event, in addition to being uncertain, is prima facie adverse to the interests of the insured. A person whose life was insured at a premium of 6d a week would presumably be a poor person and one who would have to earn his own living, and his capacity of so earning his living would probably be materially diminished by the time he reached the age of sixty-five. The reaching of that age, with its attendant disadvantages, is to my mind an event which is sufficiently adverse to the interest of a poor person to make it a proper subject against which to insure. Therefore, even if this endowment portion of the policy stood alone, and if the contract purported to be nothing more than a provision against old age, I am strongly of opinion that it would be a policy of insurance, and if a policy

of insurance, then also a policy of life insurance, for it seems clear that it would be an insurance upon a contingency relating to life — the contingency of the insured living to the age of sixty-five. But, as I have said, we must look at the contract as a whole. And when you take the whole contract together, there does not seem to be any real difficulty about the matter. A contract of life insurance is one by which persons entitle their executors to receive a sum of money for distribution among their family in the event of their death. The objection to insurance is that, if the insured lives beyond the average period of life upon which the premiums of insurance are based, he has made a bad bargain, and he would have done better if he had saved his money and invested it at compound interest. Consequently, in order to attract insurances, it is usual for the insurance companies to give benefits to persons who live beyond the average period of life. Most of them do this by way of bonuses after the policy has been in existence for a certain period, and the giving of such a bonus, of course, does not prevent the contract from being a contract of insurance. Sometimes it is provided that the sum insured shall be payable either upon the assured reaching a certain age or upon death, whichever first happens. It is clear that that also would be a contract of insurance. That is very like this case, the only difference being that here a larger sum is payable in the former event, and that is a difference which, in my opinion, is immaterial. I have come to the conclusion that this contract, taken as a whole, is clearly a contract of life insurance within the meaning of the Stamp Act, and that the appeal must, therefore, be allowed.’

[104] Department of Trade and Industry v St Christopher Motorists’ Association Ltd [1974] 1 All ER 395

[The issue before the court was whether the Association came within the terms of the relevant statutory regulation for those conducting insurance business and as such required authorisation. According to its own literature, ‘St. Christopher Motorists Association protects you against being unable to drive your car. For as little as £10 a year the St Christopher Motorists Association will help keep you on the road, when you cannot be behind the wheel. Whether disqualification or injury prevents you from driving, SCMA will provide you with a driver and, if necessary a car and driver, for up to 40 hours a week, for a maximum of 12 months.’ It was held that the Association required authorisation]. Templeman J: ‘In return for annual sums, if there happens an event which is uncertain at the date when the member joins, then on that happening the member is entitled to services and those services are to compensate him for the loss or disadvantage which has happened to him as a result of the happening of the uncertain event. Prima facie that would appear to me to be coming very near what, without any guidance, I would have thought was the essence of insurance… [His lordship next quoted extensively from Channell J’s judgment, above] Applying that definition to the present case, we have a contract not for the payment of a sum of money but for some corresponding benefit, the provision of a chauffeur or the provision of a hired car and chauffeur to become due on the happening of an event. The event is a physical accident which debars the member from driving himself or the interposition of the law which positively forbids him to drive himself. Then the event must have some amount of uncertainty about it. Well, there is a great

deal of uncertainty about it. The event must be of a character more or less adverse to the interest of the person effecting the insurance. Well, that is fulfilled here because it is adverse to the interests of the individual member that he should be immobilised either for physical reasons or because of the requirements of the law. That definition, including the learned judge’s careful pronouncement that there must either be the payment of a sum or some corresponding benefit, seems to me to meet the present case and particularly so when, in substance, there seems to me to be no difference between the defendant company paying a chauffeur on the one hand and on the other hand agreeing to pay to the individual member a sum of money which would represent the cost to him of providing himself with a chauffeur in the event of his being disabled from driving himself. I cannot see any difference in logic between the two and therefore I see no reason why, in the present particular case, the arrangement made by the defendant company should not amount to insurance. It does not follow that the definition given by Channell J in a case based on the facts with which he was concerned and applied by me to the case in which I am now concerned is an exhaustive definition of insurance. There may well be some contracts of guarantee, some contracts of maintenance which might at first sight appear to have some resemblance to the definition laid down by Channell J and which, on analysis, are not found to be true contracts of insurance at all. I wish to guard myself, particularly in view of the fact that, as I have said, counsel for the department has had no vocal opposition except mine, against deciding anything other than that the rules and trade of the defendant company in the present case amount to insurance. Counsel for the department himself suggested some further limitation in that the event which must happen must not be an event within the control of the insurer, but whether that, in fact, be so, I need not now decide. It is

sufficient for my purposes that the narrow distinction which might have been argued to differentiate the case of the defendant from the normal type of insurance, that narrow distinction being the insistence that the defendant company pays for a service instead of paying the member the amount which it will cost him to provide a service, is not one which enables the defendant company to carry on business outside the provisions of the Insurance Companies Acts.’

[105] Medical Defence Union Ltd v Department of Trade [1980] Ch 82 [The issue was whether the Medical Defence Union Ltd was carrying on insurance business within the meaning of the relevant legislation. Its membership consisted of doctors and dentists, who paid subscriptions and whose contracts with the union were governed by the terms of the union’s memorandum and articles. Among the objects of the union was giving advice on various issues, including employment, defamation and professional matters. In addition, the articles gave the union absolute discretion to undertake the conduct of any matter concerning a member’s professional character or interests and to grant an indemnity regarding any claim concerning a member’s professional character or interests]. Megarry V-C: ‘… there are two categories of insurance which may respectively be called indemnity insurance and contingency insurance. Indemnity insurance provides an indemnity against loss, as in a fire policy or a marine policy on a vessel. Within the limits of the policy the measure of the

loss is the measure of the payment. Contingency insurance provides no indemnity but instead a payment upon a contingent event, as in a life policy or a personal injury policy. The sum to be paid is not measured by the loss but is stated in the policy. The contractual sum is paid if the life ends or the limb is lost, irrespective of the value of the life or the limb. With these two categories of insurance in mind, the three elements in a contract of insurance may be expressed as follows: and in this I draw largely on what Channell J said in the Prudential case [1904] 2 KB 658, 663. First, the contract must provide that the assured will become entitled to something on the occurrence of some event. This, of course, is the disputed element, and the dispute is about what the “something” is. For Mr Chadwick it is “some benefit,” whereas for Mr Alexander it is “money or money’s worth.” To this I shall have to return. Secondly, the event must be one which involves some element of uncertainty. Mr Chadwick would add “outside the control of the insurer.” This may be right, but I do not have to decide the point, and like Templeman J in Department of Trade and Industry v St. Christopher Motorists’ Association Ltd. [1974] 1 WLR 99, 106, I leave it undecided. Thirdly, the assured must have an insurable interest in the subject matter of the contract. On the three elements as a whole, I would also follow Templeman J in the St Christopher case at p 106, and say that I do not aspire to any exhaustive or comprehensive definition, good for all purposes and in all contexts. I only say that for the purposes of this case it seems to me that a contract which contains these three elements is likely to be a contract of insurance, and a contract that lacks any of them is likely not to be a contract of insurance. I may add that Templeman J instanced some contracts of guarantee or of maintenance which might satisfy such a test and yet be no true contracts of insurance.

On the facts of this case it seems clear that all three elements are present, subject to the disputed point on the first element. That point arises in this way. On the face of the memorandum and articles a member of the union has no right to require the union to conduct legal proceedings for him, and no right to require the union to indemnify him against claims for damages. All that he has is the right to have his request for the union’s help under these heads properly considered by the council or by one of its committees. In practice it is rare for such a request to be refused. Yet although the prospects of such a request succeeding are great, all that the member has by way of right is that his request should be properly considered, and, of course, if it is granted, that the union should conduct the proceedings or indemnify him, or both. On that footing, Mr Chadwick contends that although this right is not a right to money or money’s worth, it is of value, and so is a benefit; and for the first of the three elements of insurance, all that is required is that on the occurrence of some event the assured will become entitled to some benefit. Mr Alexander, on the other hand, says that this is far too wide. The first element is satisfied if on the occurrence of the event the assured becomes entitled to a benefit consisting of money or money’s worth, but not if the only benefit is something else. As I have indicated, that is the central issue in the case. I therefore return to the main point on the footing that the right of a member in relation both to proceedings and to indemnities is merely a right to have his request fairly considered by the council or one of its committees. Only if the request is granted is the member entitled to have the proceedings conducted by the union and to have an indemnity, subject to the provisions of the articles and not least Article 44 (3). For the purposes of this case I do not think that it matters whether the right is a right to have the request heard and determined “fairly” or “in good faith.” It

is common ground that it must not be dealt with by whim or caprice, and it is not contended that such a right is valueless. As I have indicated, the short point is whether, in the first of the three elements of insurance, it suffices that on the occurrence of the event the assured becomes entitled to “some benefit,” or whether this does not suffice unless it amounts to “money or money’s worth.” The right to have a request relating to proceedings or an indemnity properly considered by the union is plainly a benefit, but equally plainly it is not money or money’s worth. Templeman J’s conclusion at p 106 was that the “careful pronouncement” of Channell J that “there must either be the payment of a sum or some corresponding benefit” met the case before him. He could see no logical difference between the club paying the driver, and the club paying the member a sum representing the cost to him of providing a driver. Such contracts were thus contracts of insurance, and so fell within the Insurance Companies Act 1974. This decision has been differently treated by different editors. In Chitty on Contracts, 24th edn. (1977), vol II, p 686, the words “to pay money” were amplified into “to pay money or provide services,” citing the St Christopher case. A warning footnote suggests that the decision may be open to question in that the extension of the definition could embrace a number of contracts not previously regarded as being contracts of insurance. A formulation in terms of the “provision of services” does not seem to me to represent the true ratio of the St Christopher case; and it appears to be at once both too wide and too narrow. The decision was based on the absence of any logical distinction between the club paying the driver and the club paying the member the cost to him of providing a driver: in each case the club met the member’s claim by paying money that it otherwise would not have paid. If instead the service provided had consisted of the club staff giving the member advice or assistance, I do not think that this would fall within the ratio of the case,

and I doubt whether it would have satisfied the requirements of insurance. Yet although in this respect the phrase “provision of services” may be too wide, in another respect it seems to be too narrow. It would include the right to the services of engineers to repair a television set when it became faulty, but not, it seems, a right to have the set replaced if it became unserviceable. It is difficult to see any sound basis for such a distinction. I do not think that this formulation should be relied on as it stands. Halsbury’s Laws of England, 4th ed, vol 25 (1978), p 9 adopts a different approach. It leaves standing the proposition stated in the previous edition, vol 22 (1958), p 180, and adds the St Christopher case…to the Prudential case…as a supporting authority. The proposition is that “a sum of money will be paid by the insurers on the happening of a specified event.” This says nothing about the person to whom the money is paid: there is no, “to or for the benefit of the assured.” Attention is thus focused on the liability of the insurers to make a payment rather than on the right of the assured to require something to be paid to him or for his benefit. This formulation certainly seems to be better supported by the St Christopher case, but I feel considerable doubt about confining it to the payment of a sum of money, thus narrowing what Channell J said in the Prudential case. If one takes again a television set, and a contract by a company that in return for an annual premium the company will replace the set when it becomes unserviceable, the requirement would be satisfied if the company had to purchase a replacement set every time an insured set became unserviceable, but it would not be satisfied if the company had replacement sets in stock: for “will be paid… on the happening of a specified event” cannot apply to what has already been paid. The exclusion of the equivalent of money may lead to curious results. Again, I would hesitate to rely on this formulation as it stands.

I do not know whether a satisfactory definition of “a contract of insurance” will ever be evolved. Plainly it is a matter of considerable difficulty. It may be that it is a concept which it is better to describe than to attempt to define; and, as I have said, I do not seek to lay down an exhaustive or comprehensive definition. It is enough if I can find a principle which suffices for the decision of the case before me. Plainly a provision for the payment of money is one of the usual elements in a contract of insurance. The main difficulty lies in formulating what extension of this concept there should be; for plainly there must be some. If the extension is framed in terms of the equivalent of money, then this will be both limited in extent and consonant with the central concept. If on the other hand the extension is framed in terms of “some benefit,” then that seems to me to be far more than a mere extension: it is a reformulation of the concept in wider terms. In other words, “money’s worth” is merely an extension of “money,” whereas “benefit” is no mere extension of “money” but a wider concept which engulfs money. “Money” would then be subsumed under “benefit,” with many other things. Obviously much is a “benefit” which is not money or money’s worth, ranging from matters such as peace and quiet to the pleasure of listening to the arguments of counsel in this case, and much else besides. I am quite unable to see any justification for replacing “money” or its equivalent by “benefit” as a constituent part of the definition of a contract of insurance. I can see nothing in the authorities which gives any real support for so wide and extensive a generalisation, especially as the term “money or money’s worth” seems to be adequate for all normal circumstances. It may be that in view of the St Christopher case…some further addition should be made so as to cover explicitly the provision of services, but I shall defer the consideration of this until I turn to the services provided by the union in this case.

In rejecting the term “benefit” I may say that I think that one is in a different world from the world of insurance when the only contractual right is a right to have a claim fairly considered. No doubt one must not attach too much importance to the basic meaning of words; but terms such as “insure” and “assure,” like “ensure,” seem to me to convey the sense of making something certain, and not merely of giving a hope or expectation, no matter how well founded. When a person insures, I think that he is contracting for the certainty of payment in specified events, and not merely for the certainty of proper consideration being given to his claim that a discretion to make a payment in those events should be exercised in his favour. The certainty must be direct, and not at one remove. There are other features in this case which are at least unusual in the case of normal contracts of indemnity insurance. Once a member has joined the union his obligation is simply to pay the annual subscription at the rate for the time being applicable to all who are in the same class of membership. However many claims have been made against him, he may remain a member at the rate of subscription common to all in his class of membership. By virtue of Articles 11, 57 and 58, so long as his name remains on the Register of Medical or Dental Practitioners and his registration has not been suspended in consequence of disciplinary proceedings, he has only to pay his subscription, and with one exception the union cannot determine his membership. That exception is where his conduct has been detrimental to the honour and interests of the union or of the medical profession: somewhat oddly, the dental profession is not mentioned. An anonymous instance of 1976 illustrates the operation of the scheme in this respect. A member had had many claims made against him. He received a warning, and then, when there was another claim, he was refused assistance. This may be contrasted with the increased annual premiums and ultimately a refusal

to renew the policy which might be expected under any normal insurance policy, and also the insurer’s obligation to meet the final claim if the policy was still in force when that claim was made. Mr Alexander also pointed to the very wide ambit that would be given to the term “contract of insurance” if Mr Chadwick’s submission on “benefit” is right. An important part of the union’s work is giving advice and assistance to members on matters other than proceedings and indemnity. Indeed, as I have mentioned, numerically, though not financially, this constitutes the great bulk of the union’s help to its members. Advice is called for on a wide range of professional work, on matters connected with contracts of employment, and on defamation. Such advice and assistance is obviously of benefit to those who receive it, and equally obviously is not money; nor, I think, could it fairly be said to be money’s worth, at all events in the sense of being the equivalent of money. The need for such advice will normally arise from some event involving an element of uncertainty, and the member plainly has an insurable interest in the successful pursuit of his career. If “benefit” is the right expression, it is difficult to see why a contract to provide such advice and assistance should not be a contract of insurance. Many professional and other bodies which give their members the right to advice and assistance may thus be brought within the Act, or at least be in danger of being treated as such. Like Monsieur Jourdain, who was astonished to find that for 40 years he had been speaking prose without knowing it, such bodies might equally be astonished to discover that for many years they have been insurance companies carrying on insurance business without knowing it, or at least that they were in peril of being so regarded. In view of the St Christopher case…it may be that the term “money or money’s worth” will not suffice by itself. A possible addition would be “or the provision of services to be paid for by the insurer.” The last seven words are

intended to reflect the fact that in the St Christopher case the provision of the services for each member was an additional cost for the club, incurred when the member made his claim, and was not merely part of the general costs of running the club for the benefit of members generally. As at present advised I would hesitate to omit these last seven words. If members of a club or other body have the right to be given advice and assistance by the staff of that body, so that the provision of this advice or assistance to any individual member adds nothing to the expenses of the body, I doubt whether this could fairly be regarded as being insurance. Looking at the case as a whole I have no hesitation in rejecting Mr Chadwick’s contention that the union is an insurance company carrying on insurance business within the meaning of the Act of 1974. I do not have to decide whether “money or money’s worth,” with or without an addition relating to providing services such as I have discussed, is the right phrase to appear in the first of the three elements of a contract of insurance. I only say that I think that something of that kind is probably on the right lines. What I do decide is that “benefit” is far too wide an expression, and I reject it. In particular, I reject the contention that the right to have an application properly considered suffices for a contract of insurance. I also consider that the general nature of the business carried on by the union is too far removed from the general nature of the businesses carried on by those who are generally accepted as being insurers for the union’s business to be fairly regarded as the effecting and carrying out of contracts of insurance. …I do not think that my decision is likely to open the door to colourable evasions of a beneficial statute. I very much doubt whether commercial concerns will find it possible to establish thriving businesses which are insurance businesses in substance and yet escape the Act. It seems

improbable in the extreme that many people would be content for their premiums to purchase no right to any money or money’s worth in any event but merely a right to have their claims considered by a body of directors or others with full discretionary power to pay nothing or merely as much as they think fit. Where the body concerned, like the union in the present case, is run by honourable members of an honourable profession it may well be that many members of that profession will be content to rely on the discretion being always exercised in a proper way by the governing body which they elect, with meritorious claims being admitted and the unmeritorious excluded; but this reliance does not convert a legitimate expectation of receiving discretionary benefits in all proper cases into a contractual right to receive those benefits.’

[106] FSA, The Authorisation Manual: Consultation on Draft Guidance on the Identification of Contracts of Insurance, Consultation Paper 150 (London, FSA, 2002) [The Financial Services and Markets Act 2000 and the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (as amended), which sets out the activities for which authorisation is required, do not provide a definition of ‘contract of insurance’. However, the Financial Services Authority has recognised in a way that its predecessor, the Department of Trade and Industry, seemed not to, that in view of both the general prohibition against firms engaging in insurance business without authorisation (s 19(1) FSMA) and the general policy of improving transparency, there is a need to provide

firms and contractors with guidelines as to the activities which the FSA consider to be insurance]. ‘1.3.2 The Regulated Activities Order, which sets out the activities for which authorisation is required, does not attempt an exhaustive definition of a ‘contract of insurance’. Instead, R makes some specific extensions and limitations to the general common law meaning of the concept. For example, it expressly extends the concept to fidelity bonds and similar contracts of guarantee, which are not contracts of insurance at common law, and it excludes certain funeral plan contracts, which would generally be contracts of insurance at common law. Similarly, the Exemption Order excludes certain trade union provident business, which would also be insurance at common law. One consequence of this is that common law judicial decisions about whether particular contracts amount to ‘insurance’ or ‘insurance business’ are relevant in defining the scope of the FSA’s authorisation and regulatory activities, as they were under predecessor legislation. 1.3.3 The courts have not fully defined the common law meaning of ‘insurance’ and ‘insurance business’, since they have, on the whole, confined their decisions to the facts before them. They have, however, given useful guidance in the form of descriptions of contracts of insurance. 1.3.4 The best established of these descriptions appears in the case of Prudential v Commissioners of Inland Revenue [1904] 2 KB 658. This case, read with a number of later cases, treats as insurance any enforceable contract under which a ‘provider’ undertakes: (1) in consideration of one or more payments;

(2) to pay money or provide a corresponding benefit (including in some cases services to be paid for by the insurer) to a ‘recipient’ (3) in response to a defined event; (4) the occurrence of which is uncertain (either as to when it will occur or as to whether it will occur at all); and (5) adverse to the interests of the recipient. 1.3.5 The courts have not, so far, taken account of the balance of regulatory cost and benefit in deciding whether a particular contract should be classified as insurance. In Fuji v Aetna [1997] Ch 173 (CA), the court decided that the regulatory consequences of treating a contract as insurance were not relevant to the classification of that contract. 1.4 Limitations of this guidance 1.4.1 Although what appears below is the FSA’s approach, it cannot be definitive of the law, which is a matter for the courts. Accordingly, this guidance is not a substitute for adequate legal advice on any transaction. 1.4.2 The list of factors is not closed and the guidance by no means covers all types of insurance-like business. 1.4.3 The FSA will consider each case on its facts and on its merits. 1.4.4 In some cases transactions with the same commercial purpose may be classified as either insurance or noninsurance. This will depend on the features of the particular contract under which the transaction is effected or carried out. 1.5 General principles 1.5.1 The starting point for the identification of a contract of insurance is the description set out in 1.3.4. Any

contracts which fall outside that description are very unlikely to be contracts of insurance. 1.5.2 In identifying a contract of insurance, the substance of the contract prevails over its form. This was the effect of the court decisions in Fuji v Aetna [1997] Ch 173 (CA), and In re Sentinel Securities [1996] 1 WLR 316. The FSA will adopt the same approach, looking primarily at the substance of the provider’s rights and obligations under the contract. 1.6 The factors 1.6.1 Contracts under which the provider has an absolute discretion as to whether any benefit is provided on the occurrence of the uncertain event, are not contracts of insurance. This may be the case even if, in practice, the provider has never exercised its discretion so as to deny a benefit… 1.6.2 Contracts covering risks or losses, the insurance of which would be general insurance business, are unlikely to be regarded as contracts of insurance if the provider assumes no risk as a result of having effected them. The “assumption of risk” concept is illustrated in 1.7.2 G (Example 2: Disaster Recovery Business). 1.6.3 In the FSA’s view, the same principle should apply in general to contracts covering risks the insurance of which would comprise long-term insurance business. However, the courts have, on specific facts, characterised some contracts of this kind as insurance, even though the insurer did not assume any risk. See Fuji v Aetna [1997] Ch 173 (CA), citing Joseph v Law Integrity [1912] 2 Ch 581 (C.A.) and Flood v Irish Provident [1912] 2 Ch 597 (CA). 1.6.4 Contracts under which the occurrence of the uncertain event lies solely within the control of the provider are unlikely to be regarded as insurance, because there will be no transfer of risk.

1.6.5 Contracts under which the amount and timing of the payments made by the recipient makes it reasonable to conclude that there is a genuine prepayment for services to be rendered in response to a future contingency, are unlikely to be regarded as insurance. In general, the FSA expects that this requirement will be satisfied where there is a commercially reasonable and objectively justifiable relationship between the amount of the payment and the cost of providing the contract benefit. 1.6.6 Contracts under which the provider undertakes to provide periodic maintenance of goods or facilities, whether or not any uncertain or adverse event (in the form of, for example, a breakdown or failure) has occurred, are unlikely to be contracts of insurance. 1.6.7 Contracts under which, in consideration for an initial payment, the provider stands ready to provide services on the occurrence of a future contingency, on condition that the services actually provided are paid for by the recipient at a commercial rate, are unlikely to be regarded as insurance… 1.6.8 The recipient’s payment for a contract of insurance need not take the form of a discrete or distinct premium. Consideration may be part of some other payment, for example the purchase price of goods (Nelson v Board of Trade (1901) 17 TLR 456). Consideration may also be provided in a nonmonetary form, for example as part of the service that an employee is contractually required to provide under a contract of employment (Australian Health Insurance Assoc. Ltd v Esso Australia Ply Ltd (1993) 116 ALR 253). 1.6.9 The following factors are also relevant: (1) a contract is more likely to be regarded as a contract of insurance if the amount payable by the recipient under the contract is calculated by

reference to either or both of the probability of occurrence or likely severity of the uncertain event; (2) a contract is less likely to be regarded as a contract of insurance if it requires the provider to assume a speculative risk (ie a risk carrying the possibility of either profit or loss) rather than a pure risk (ie a risk of loss only); (3) a contract is more likely to be regarded as a contract of insurance if the contract is described as insurance and contains terms that are consistent with its classification as a contract of insurance, for example, obligations of the utmost good faith; (4) a contract that contains terms that are inconsistent with obligations of good faith may, therefore, be less likely to be classified as a contract of insurance; however, since it is the substance of the providers rights and obligations under the contract that is more significant, a contract does not cease to be a contract of insurance simply because the terms included are not usual insurance terms.

Note: This passage is followed by illustrations of the application of the principles: for example, a medical scheme, which formed an employee benefit, would be insurance if the employee had a right to that benefit, but not if the employer had an absolute discretion over the benefits.

[107] Insurance Act, RSA 1980, c 1–5 (Alberta), s 1(k 1) ‘[insurance is] the undertaking by one person to indemnify another person against loss or liability for loss in respect of certain risk or peril to which the object of the insurance might be exposed, or to pay a sum of money or other thing of value on the happening of a certain event’.

[108] Saskatchewan Crop Insurance Corp v Greba (1997) 154 Sask R 289 (Saskatchewan Court of Queen’s Bench) Harbinsky J: ‘A contract of insurance is a contract whereby the insurer promises in return for payment of a premium by the insured to pay the insured a sum of money upon the occurrence of one or more specified events, the occurrence of which is uncertain. To obtain insurance the insured must have an insurable interest in the property insured.’

[109] Glynn v Scottish Union & National Insurance Co Ltd (1963) 40 DLR (2d) 929 (Ontario Court of Appeal) Kelly JA: ‘Speaking generally with respect to all insurance other than life, the purpose of insurance is to relieve the insured in whole or in part from the financial impact of some contingent event, by shifting the risk of the insured’s possible loss to the shoulders of the insurer, a person who for a pecuniary consideration is willing to assume the risk, up to a maximum amount stated in the contract, of the peril insured against’.

[110] California Insurance Code § 22 (2000) ‘Insurance is a contract whereby one undertakes to indemnify another against loss, damage, or liability arising from a contingent or unknown event.’

[111] New York Consolidated Laws Services Ins § 1101 (1999) ‘[an insurance contract is] any agreement or other transaction whereby one party, the “insurer”, is obligated to confer benefit of pecuniary value upon the happening of a fortuitous event in which the “insured” or “beneficiary” has, or is expected to have at the time of such happening, a material interest which will be adversely affected by the happening of such event.’

[112] Union Labor Life Insurance Co v Pireno 458 US 119 (US Supreme Court, 1982) Justice Brennan: ‘In sum [Group Life & Health Insurance. Co v Royal Drug Co (1970) 440 US 205 (Supreme Court of the United States)] identified three criteria relevant in determining whether a particular practice is part of the “business of insurance” exempted from the antitrust laws [under the McCarrenFerguson Act 1945]…: first, whether the practice has the effect of transferring or spreading a policyholder’s risk; secondly, whether the practice is an integral part of the policy relationship between the insurer and the insured; and thirdly, whether the practice is limited to entities within the insurance industry.’

[113] Professor Vance, Handbook on the Law of Insurance (ed, BM Anderson), (St Paul, Minn, West Publishing: 1951) [Professor Vance specified the following requirements for an enforceable insurance contract:] ‘(a) The insured possesses an interest of some kind susceptible of pecuniary estimation, known as an insurable interest. (b) The insured is subject to a risk of loss through the destruction or impairment of that interest by the happening of designated perils. (c) The insurer assumes that risk of loss. (d) Such assumption is part of a general scheme to distribute actual losses among a large group of persons bearing somewhat similar risks. (e) As consideration for the insurer’s promise, the insured makes a ratable contribution, called a premium, to a general insurance fund. A contract possessing only the three elements first named is a risk-shifting device, but not a contract of insurance, which is a risk-distribution device; but, if it possesses the other two as well, it is a contract of insurance, whatever be its name or its form.’

Notes: 1. Channell J’s definition has enjoyed general approval in the English courts: see Joseph v Law Integrity Insurance Co Ltd [1912] 2 Ch 581 (CA); Flood v Irish Provident Assurance Co Ltd (Note) [1912] 2 Ch 597; Gould v Curtis [1913] 3 KB 84 (CA); Department of Trade and Industry v St Christopher Motorists’ Association Ltd [1974]

1 WLR 99; Medical Defence Union Ltd v Department of Trade [1979] 2 WLR 686; Fuji Finance Inc v Aetna Life Insurance Co Ltd [1997] Ch 173 (CA). Generally, R Hodgin, ‘Problems in Defining Insurance Contracts’ [1980] LMCLQ 14. 2. Uncertainty or risk has often been mentioned as an important indicator of the existence of an insurance contract; indeed, where the loss is known there can be no insurance — referred to as the ‘known loss’ rule in the USA. In Re Barrett; Ex parte Young v NM Superannuation Pty Ltd 106 ALR 549 (Fed Court of Australia, 1992), von Doussa J, referred with approval to Channell J’s judgment, adding that, ‘uncertainty [concerning the happening of the event] gives rise to uncertainty as to both profit and loss to the insurer which is a distinguishing characteristic of a contract of insurance…A contract of insurance is a contract upon speculation.’ However, there has been criticism of Channell J’s view that the uncertain event must be ‘primâ facie adverse to the interest of the assured’: see Gould v Curtis [1913] 3 KB 84 (CA), per Cozens-Hardy MR, in which case Buckley LJ remarked, concerning a life policy, ‘some people regard [death] as adverse, and some do not’. As has been seen, Channel J himself felt that reaching 65 years of age might be regarded as an adverse event for a poor person.

3. It has also been pointed out that central to insurance is an agreement to shift and distribute risk. In Metropolitan Life Insurance Co v State Board of Equalization 652 P2d 426 (Supreme Court of California, 1982), it was said of the definition of insurance in the California Insurance Code (above) that it required, ‘(1) a risk of loss to which one party is subject and a shifting of that risk to another party; (2) distribution of risk among similarly situated persons.’ In Truta v Avis Rent A Car System, Inc 193 Cal App 3d 802 (Court of Appeal, California, 1987) it was held that a collision damage waiver provision in a car rental contract did not amount to insurance because the company did not undertake to assume liability for third party risk but merely agreed not to insist that the person hiring the car make payments for certain types of damage which otherwise would be due to the company. See also, Re Commonwealth Homes & Investment Co Ltd [1943] SASR 211 (South Australia Supreme Court); The Motorcycle Specialists Ltd v Attorney-General (1988) 5 ANZ Insurance Cases 60–882. 4. A characteristic of insurance not mentioned by Channell J is that the contract must be such as would justify the parties being placed under a duty of utmost good faith. This was discussed by the Court of Appeal in Seaton v Heath [1899] 1 QB 782 (see below) and also In Re Denton’s Estate [1904] 2 Ch 178 (CA) where

Vaughan Williams LJ distinguished a contract of insurance from a contract of guarantee: ‘The distinction in substance, in cases in which the loss insured against is simply the event of the nonpayment of a debt, seems to be, as I read the judgment of Romer L.J. [in Seaton v Heath], between contracts in which the person desiring to be insured has means of knowledge as to the risk and the insurer has not the same means, and those cases in which the insurer has the same means.’

5. In one California case the court determined whether a subscriber medical contract for the poor was insurance or not by asking if ‘“service” rather than “indemnity” is its principal object and purpose’ (California Physicians’ Service v Garrison 172 P2d 4 (1946)). 6. ‘There is much to be said for the view that it is the relationship of indemnity that exists between insurer and insured, rather than the source of that relationship, that is the essence of the concept of insurance, so that it matters not whether the relationship arises by statute or by contract.’ (R v Cohen; Ex parte Motor Accidents Insurance Board (1979) 141 CLR 577 (High Court of Australia), per Mason J. In that case it was determined that there was no ‘insurance business’ where compensation was paid by a body under a statutory scheme irrespective of liability at common law. See also Australian Health Insurance Association Ltd v

Esso Australia Ltd 41 FCR 450 (Federal Court of Australia, 1993); Fortin v Li [1994] 1 WWR 709 (Supreme Court, British Columbia). 7. The premium can be a single payment or a series of payments. The level at which it is set is a matter for the insurers and need not be designed to produce a profit. Nicholls V-C made the suggestion in Fuji Finance Inc v Aetna Life Insurance Co Ltd [1995] Ch 122 that the payment should in some sense be related to the risk. This may cause some difficulties in relation to offers of ‘free insurance’ (J Lowry and P Rawlings, Insurance Law: Doctrines and Principles (Oxford, Hart Publishing, 1999) at 5– 7), but it is important to distinguish between a payment that amounts to a premium and one that is simply a fee. In Australian Health Insurance Association Ltd v Esso Australia Ltd (1993) 41 FCR 450 (Federal Court of Australia), an arrangement was held be insurance under which Esso’s employees were provided with health care. The employees paid a premium that covered about one-fifth of the cost of the scheme, with Esso paying the remainder. ‘suppose an insurance company decided, for the purpose of attracting custom in a particular segment of its insurance business, to lower its premiums so that they were less than an actuarial apportionment to the risk would require. It could not sensibly be suggested that the transaction in which lower premiums were charged did not involve undertaking liability by way of insurance,

and the reason why it could not be so suggested is that the essence of the relationship between insurer and insured would remain, namely the relationship of indemnity in the context of contingent loss.’ (per Black CJ. See also, R v Cohen; Ex parte Motor Accidents Insurance Board (1979) 141 CLR 577 (High Court of Australia), per Mason J)

The failure to set a premium in the contract is not necessarily fatal. The Marine Insurance Act 1906, s 31(1) acknowledges the common practice of effecting marine policies at a premium ‘to be arranged’ (or simply ‘TBA’), which means ‘a reasonable premium is payable’ calculated at the prevailing market rate (see also, s 31(2); Liberian Insurance Agency Inc v Mosse [1977] 2 Lloyd’s Rep 560). This statute also recognises mutual insurance arrangements, which involve no payment of a premium (s 85).

1.4 Life Assurance As has been seen (Medical Defence Union case, above), insurance contracts can be divided into indemnity and contingency. Life assurance comes within the second category and involves some different characteristics. [114] C J Bunyon, The Law of Life Assurance (4th Edn) (Ed JV Vesey Fitzgerald) (London: Charles and Edwin Layton, 1904) at 1

‘The contract of life insurance may be…defined to be that in which one party agrees to pay a given sum upon the happening of a particular event contingent upon the duration of human life, in consideration of the immediate payment of a smaller sum or certain equivalent periodical payments by another.’

Note: See also, F Blayney, A Practical Treatise on LifeAssurance (London: J & WT Clarke, 1826), p 1 [115] Insurance Act, RSA 1980, c 1–5 (Alberta), s 1 (m 1) [Life insurance is insurance] ‘whereby an insurer undertakes to pay insurance money (i) on death, (ii) on the happening of an event or contingency dependent on human life, (iii) at a fixed or determinable future time, or (iv) for a term dependent on human life’

Note: There are different types of life policies. First, whole life insurance provides cover until the death of the insured at which point a sum is paid to the specified beneficiary. Secondly, term insurance pays out if the death occurs within the specified term, but if the insured life is alive at the end of the term the policy lapses. A level term policy pays out the same amount whenever death occurs within the term; a decreasing term policy pays an amount that gradually reduces should death occur during the term; under an

increasing term policy the amount paid to the insured increases; a renewable term policy allows the insured to take out a new term policy at the expiry of the initial policy without providing fresh proof of good health; a convertible term policy allows the insured to convert the policy into whole life or endowment without providing evidence of good health; and a family income benefit policy provides an income to the beneficiary for the remainder of the term after the death of the insured. Third, an endowment policy combines aspects of life insurance with investment. Typically these policies promise a fixed sum where death occurs within a particular period of time, but if the insured life survives beyond that period the entitlement is to the accrued value of the investment part of the policy. The use of life insurance as a minor part of an investment package has become popular, and the following cases suggest that, even if the main purpose is investment, the agreement will still be insurance. [116] Fuji Finance Inc v Aetna Life Insurance Co Ltd [1997] Ch 173 (CA) [Insurers issued to Fuji what was referred to as a life assurance policy or a capital investment bond for which they received a single premium of £50,000. The life assured was Mr Tait, who was involved in the management of Fuji. Under condition 5 the benefit was due on Tait’s death, although condition 7 provided that it would be paid where the policy was surrendered before death. The premium was applied

to buy units in funds administered by the insurers and the policy’s value was calculated according to the value of those units. Fuji had the option to shift between the different funds. It was evident that Fuji’s principal aim was to increase the value of the policy, and, indeed, by exploiting the rules relating to shifting between the funds, Fuji did increase its value to over £2 million in just six years. In considering whether this was a life policy or merely an investment, Nicholls V-C, at first instance, proposed ‘the principal object test’ by which ‘only where the principal object is to insure can a contract as a whole be called a contract of insurance’. The Court of Appeal rejected this test and held that the contract was one of insurance]. Morritt LJ: ‘The essence of life assurance, as emphasised in all the cases, is that the right to the benefits is related to life or death. The obvious case, like condition (5), is where the benefit is payable on death or its notification. But over the years other less obviously life- or death-related events have been recognised as sufficient. Thus, survival to a given date, as in Joseph v Law Integrity Insurance Co Ltd [1912] 2 Ch 581, or the exercise of an option to determine given only to the personal representatives of the policyholder, as in In re National Standard Life Assurance Corporation [1918] 1 Ch 427, being alive and therefore able to retire or leave a specified employment, as in NM Superannuation Ply. Ltd v Young, 113 ALR 39, have all been recognised as being sufficiently related to life or death. In this case, as counsel for Fuji accepted, the policy came to an end on the death of Mr Tait so that, subject to notification in the prescribed manner, the benefits then crystallised. Thus the right to

surrender was related to the continuance of life for it could not be exercised by Fuji after the death of Mr Tait. I do not suggest that a policy which contained condition (7) without also including condition (5) would be a policy of life assurance. But I see no reason why a policy which contains both should be denied that character. If the event on which a benefit is payable is sufficiently life- or death-related then I can see no reason in principle why it should matter if that benefit is the same as that payable on another life- or death-related event. That is a matter for the insurer and it is well established that it is not necessary that the insurer should be exposed to any risk at all: Flood v Irish Provident Assurance Co Ltd (Note) [1912] 2 Ch NM Superannuation Pty v Young 113 ALR 39.’

[117] Marac Life Assurance Ltd v Commissioner of Inland Revenue [1986] 1 NZLR 694 (Court of Appeal, New Zealand) Richardson J: ‘The true nature of a transaction can only be ascertained by careful consideration of the legal arrangements actually entered into and carried out: not on an assessment of the broad substance of the transaction measured by the results intended and achieved or of the overall economic consequences. The nomenclature used by the parties is not decisive and what is crucial is the ascertainment of the legal rights and duties which are actually created by the transaction into which the parties entered. The surrounding circumstances may be taken into account in characterising the transaction. Not to deny or contradict the written agreement but in order to understand the setting in which it was made and to construe it against that factual background having regard to the genesis and objectively the aim of the transaction. Of course, the documentation

may be a sham hiding the true agreement or its implementation. Or there may be a statutory provision mandating a broader or different approach. But at common law there is no half-way house between sham and characterisation of the transaction according to the true nature of the legal arrangements actually entered into and carried out…On its face…each type of bond is in form a classic contract of endowment assurance. Each contains the essential distinguishing features of a policy of life insurance. Marac guarantees to pay from day one a sum in excess of the premium if the life assured dies prior to the maturity date. That guarantee provides a significant and measurable level of death cover capable of arithmetical measurement. For its part Marac bears from day one an insurance risk that is dependent upon human life inasmuch as it has contracted to pay both the sum guaranteed on death and the sum guaranteed on survival to the maturity date. The risk is readily capable of actuarial calculation and such calculations were made and taken into account in deciding on the premiums to be charged in return for the consideration to be provided by Marac.’

Notes: 1. The Financial Service Authority, in its Interim Prudential Sourcebook: Insurers (part of the FSA’s Handbook, see chapter 2), states: ‘3.5A(1) Before entering into a long-term insurance contract, a UK insurer must satisfy itself that the aggregate of — (a) the premiums payable under the contract and the income which will be derived from them; and

(b) any other resources of the UK insurer which are available for the purpose, will be sufficient, on reasonable actuarial assumptions, to meet all commitments arising under or in connection with the contract. (2) A UK insurer must not rely on other resources for the purposes of (1) in such a way as to jeopardise its solvency in the long term.’

This would seem to prohibit the type of contract used in Fuji where the size of the insurer’s commitment is not related to premiums or income derived from premiums. See R Merkin, ed, Colinvaux & Merkin’s Insurance Contract Law (London, Sweet & Maxwell, 2002). 2. Richardson J’s judgment was cited with approval in the Australian case NSM Superannuation Pty Ltd v Young (1993) 41 FCR 182 at 200–1, per Hill J. Securities and Exchange Commission v Variable Annuity Life Insurance Company of America 3 L ed 2d 640 (US Supreme Court, 1959) involved a contract that shared features with that in the Fuji case. Here the annuity continued until the death of the annuitant; payments were made periodically, the money was invested in stocks and the benefit due varied according to the success of those investments. Douglas J, for the majority, said that the contract was investment not insurance: ‘we conclude that the concept of “insurance” involves some investment risk-

taking on the part of the company. The risk of mortality, assumed here, gives these variable annuities an aspect of insurance. Yet it is apparent, not real; superficial not substantial. In hard reality the issuer of a variable annuity that has no element of a fixed return assumes no true risk in the insurance sense. It is no answer to say that the risk of declining returns in times of depression is the reciprocal of the fixed-dollar annuitant’s risk of loss of purchasing power when they are low. We deal with a more conventional concept of riskbearing when we speak of “insurance”. For in common understanding “insurance” involves a guarantee that at least some fraction of the benefits will be payable in fixed amounts.’ Harlan J (with whom three others joined) dissented, arguing that ‘the mortality aspect of these annuities — that is the assumption by the company of the entire risk of longevity — involves nothing other than classic insurance concepts and procedures’.

1.5 Gaming Contracts In the next few sections, contracts that share features with insurance will be considered and distinguished. The first of these are gaming contracts. Wagers are not in themselves unlawful at common law, so the need to distinguish between them and insurance only arose as Parliament began

to intervene in the mid-eighteenth century to make certain types of wagers unenforceable. The distinction between the two contracts was drawn around the issue of insurable interest. See, R Merkin, ‘Gambling by Insurance — A Study of the Life Assurance Act 1774’, [1981] Anglo-American Law Review 331. [118] Carlill v Carbolic Smoke Ball Co [1892] 2 QB 484 Hawkins J: ‘It is not easy to define with precision what amounts to a wagering contract, nor the narrow line of demarcation which separates a wagering from an ordinary contract, but, according to my view, a wagering contract is one by which two persons, professing to hold opposite views touching the issue of a future uncertain event, mutually agree that, dependent upon the determination of that event, one shall win from the other, and that other shall pay or hand over to him, a sum of money or other stake; neither of the contracting parties having any other interest in that contract than the sum or stake he will so win or lose, there being no other real consideration for the making of such contract by either of the parties. It is essential to a wagering contract that each party may under it either win or lose, whether he will win or lose being dependent on the issue of the event, and, therefore, remaining uncertain until that issue is known. If either of the parties may win but cannot lose, or may lose but cannot win, it is not a wagering contract.’

[119] Utah Code Ann § 76–10–1101:

‘Gambling” means risking anything of value for a return or risking anything of value upon the outcome of a contest, game, gaming scheme, or gaming device when the return or outcome is bound upon an element of chance and is in accord with an agreement or understanding that someone will receive something of value in the event of a certain outcome, and gambling includes a lottery; gambling does not include: a) a lawful business transaction, or (b) playing an amusement device that confers only an immediate and unrecorded right of replay not exchangeable for value’.

Note: Hawkins J’s definition was cited with approval in Australian Capital Territory Gaming and Liquor Authority v Andonaros (1991) 103 FLR 450 (Australian Capital Territory, Supreme Court), 460 per Miles CJ.

1.6 Contracts of Guarantee One of the key features of property insurance is that one party indemnifies the other against loss, but this is also an essential element in a contract of guarantee or suretyship. Both contracts also share other features such as rights of subrogation. As a result, as Harman LJ observed, the attempt to differentiate between these two types of contract ‘has raised many hair-splitting distinctions of exactly the kind which brings the law into hatred, ridicule and contempt by the public’ (Yeoman Credit Ltd v Latter [1961] 1 WLR 828, cited in J. Beatson, ed, Anson’s

Law of Contract (Oxford, Oxford University Press, 2002) at 79). Distinctions can be drawn, however. Most notable of these is that an insurance contract generally requires the insured to pay a premium, which is, broadly, determined by the level of risk run by the insurer, whereas a contract of guarantee can be (and usually is) entered without any payment. Moreover, at the time a contract of insurance is made it involves only two parties — the insured and the insurer — whereas with a guarantee there are three parties — the creditor, the debtor and the guarantor. [120] Seaton v Heath [1899] 1 QB 782 (CA) Romer LJ: ‘…I desire to make some remarks upon the question of general importance raised in this case with reference to the contract of insurance or guarantee. There are some contracts in which our Courts of law and equity require what is called “uberrima fides” to be shewn by the person obtaining them; and, as that phrase is short and convenient, I will continue to use it. Of these, ordinary contracts of marine, fire, and life insurance are examples, and in each of them the person desiring to be insured must, in setting forth the risk to be insured against, not conceal any material fact affecting the risk known to him. On the other hand, ordinary contracts of guarantee are not amongst those requiring “uberrima fides” on the part of the creditor towards the surety; and mere non-communication to the surety by the creditor of facts known to him affecting the risk to be undertaken by the surety will not vitiate the contract, unless there be fraud or misrepresentation, and misrepresentation undoubtedly might be made by concealment. But the difference between these two classes of contract does not

depend upon any essential difference between the word “insurance” and the word “guarantee.” There is no magic in the use of those words. The words, to a great extent, have the same meaning and effect; and many contracts, like the one in the case now before us, may with equal propriety be called contracts of insurance or contracts of guarantee. Whether the contract be one requiring “uberrima fides” or not must depend upon its substantial character and how it came to be effected. There is no hard and fast line to be drawn between contracts of insurance and contracts of guarantee for the purpose for which I am now considering them; and certainly the rule as to contracts of insurance is not limited, as contended, to the three forms of marine, life, and fire insurance: see the observations of Jessel MR in London Assurance v Mansel [11 Ch D 363]. Now when contracts of insurance are considered it will be seen that, speaking generally, they have in common several features in their character and the way they are effected which distinguish them from ordinary contracts of guarantee. Contracts of insurance are generally matters of speculation, where the person desiring to be insured has means of knowledge as to the risk, and the insurer has not the means or not the same means. The insured generally puts the risk before the insurer as a business transaction, and the insurer on the risk stated fixes a proper price to remunerate him for the risk to be undertaken; and the insurer engages to pay the loss incurred by the insured in the event of certain specified contingencies occurring. On the other hand, in general, contracts of guarantee are between persons who occupy, or ultimately assume, the positions of creditor, debtor, and surety, and thereby the surety becomes bound to pay the debt or make good the default of the debtor. In general, the creditor does not himself go to the surety, or represent, or explain to the surety, the risk to be run. The surety often takes the position from motives of friendship to the debtor, and generally not as the result of any direct

bargaining between him and the creditor, or in consideration of any remuneration passing to him from the creditor. The risk undertaken is generally known to the surety, and the circumstances generally point to the view that as between the creditor and surety it was contemplated and intended that the surety should take upon himself to ascertain exactly what risk he was taking upon himself. In all the reported cases of guarantees that I have been able to find, in which it has been held that the party guaranteed owed no duty to the guarantor as to disclosure of material facts, the contracts, when examined, are found to have in substance, though of course not in every detail, the characteristics which distinguish contracts of guarantee from contracts of insurance as above stated by me. Applying the above considerations to the contract in the case before us, it appears to me that the contract is one which required “uberrima fides” on the part of the insured.’

[121] United States v Tilleraas 709 F2d 1088 (US Court of Appeals, 6th cir, 1983) Wellford J: ‘Insurance is a contract where one undertakes to indemnify another against loss, damage or liability caused by an unknown or contingent event. Since the insured pays the insurer for the promise of indemnity, the insurer benefits to the extent that a contingency never occurs. Where a contingency does occur, the insurer can still be made whole, by virtue of subrogation, to the extent that the insured would be able to recover damages from a third party. Despite the presence of this right of subrogation it is clear that when the contract is formed all legal rights and obligations flow between the insurer and the insured. At this initial stage, there is no legal obligation owing from the third party to the insurer. In fact, it is unknown at that stage

whether such a third party obligation will ever arise and, if so, who that third party will be. A surety, on the other hand, promises to assume the responsibility for the payment of a debt incurred by another should he or she fail to repay the creditor. The arrangement is made to induce the creditor to deal with the borrower where there might otherwise be a reluctance to do so. Under this arrangement, the nature, size, and source of the possible loss to the creditor is known from the start. In addition, there is no payment from the creditor to the surety or guarantor for this “insured” payment. Rather, a kind of tripartite relationship is formed. The consideration running from the creditor to the debtor is deemed sufficient to support the surety’s promise to make the debt good. In turn, the benefit flowing to the debtor by virtue of the surety’s promise places that debtor under an implied legal obligation to make good any loss incurred by any payment the surety must ultimately make to the creditor. 74 AmJur2d Suretyship § 171 (1974). It is clear then that the two contracts are materially distinguishable, as are the rights and duties of the parties involved.’

Note: In an Irish case, International Commercial Bank plc v Insurance Corporation of Ireland plc and Meadows Indemnity Company Ltd (third party) [1991] ILRM 726 (High Court), Blayney J adopted the Romer test. The case involved what the parties called a ‘credit guarantee insurance agreement’, which had been taken out to secure a loan from a bank. It was held to be a contract of guarantee not of insurance because it had been obtained by the borrower as security for the bank rather than by the bank as protection

against a potential loss, because the agreement had a number of clauses which were only appropriate to a guarantee, and because it specified the consideration for the agreement as being the granting of the loan.

1.7 Contracts of Warranty In a contract for the sale of goods it is commonplace for the seller to promise to repair or replace faulty goods, and there seems no reason to suppose that this practice will disappear following the Sale and Supply of Goods to Consumers Regulations 2002, which, under certain circumstances, require the seller to repair goods. Some sellers extend this promise to faults not present at the time of purchase, or the buyer may enter a separate repair agreement with a third party — that is someone other than the seller — in exchange for a fee (see the comments of Megarry V-C in Medical Defence Union, above). The jurisprudence on the distinction between contracts of warranty and of insurance is fairly sparse in English law, and even in the USA, where there has been a good deal of case-law, confusion remains (see, generally, an old but instructive comment at (1938) 25 Va L Rev 238). [122] Ollendorf Watch Co v Pink 17 NE2d 676 (Court of Appeals, New York, 1938) [A promise by the seller of a watch to provide a replacement if it was lost or stolen within 12 months was held to be a

contract of insurance].

Crane CJ: ‘This goes further than a guarantee or warranty. For instance, a warranty would relate in some way to the nature or efficiency of the product sold — in this case, that the watch would work or was of a certain make and fineness. A warranty would not cover a hazard having nothing whatever to do with the make or quality of the watch…This contract goes much further. It has nothing whatever to do with the sale of the watch or the contract of sale. It is an extraneous inducement to procure sales. If the watch is stolen the seller will replace it. In other words, he takes a chance or a risk of theft from his customers; that is, he insures them for a year against such risk.’

[123] GAF Corp v County School Board of Washington County 629 F 2d 981 (US Court of Appeals, 4th Cir, 1980) [GAF fitted a roof and promised to repair any damage caused by faulty materials or faulty workmanship. At first instance, this was held to be insurance because the promise about workmanship was unrelated to defects present in the goods themselves. That ruling was reversed on appeal].

Phillips J: ‘Although…the guarantee here possesses some characteristics of insurance, we think that this does not sufficiently address the underlying question and that the guarantee must be viewed as a whole in determining whether it constitutes a contract of insurance or a warranty.’

Note:

In the GAF Corp case the agreement did not become insurance merely because it involved the transfer of risk since, in the words of Phillips J, this was ‘a relatively unimportant element of the transaction and is incidental to the essential character of the guarantee’, which was a warranty agreement accompanying a contract for the sale of goods. In Griffin Sys v Washburn 505 NE2d 1121 (Appellate Court of Illinois, 1987), Griffin offered motorists contracts under which, in exchange for a payment, the company would repair damage to the car caused by, among other things, weather, collision, vandalism, negligence or failure to perform service maintenance. This was held to be insurance. The court distinguished between the situation where a consumer purchased from the manufacturer or the retailer of the product a service contract that provided a warranty and the situation where the socalled ‘warranty’ was purchased from a third party. The court took the view that only the latter met the criteria for insurance in that there was a contract for a specific period of time between the third party and the buyer; that the buyer had an insurable interest; that consideration in the form of a premium had been paid by the buyer to the third party; and that the third party had assumed risk by agreeing to indemnify the buyer against any pecuniary loss resulting from the specified perils. The court pointed out that whereas in a warranty the retailer of a product was responsible for making good a defective product, in insurance the insurer indemnifies the consumer against loss. Linn J commented that,

‘Insurance is generally understood to be an arrangement for transferring and distributing risks. Unfortunately, this characterisation is neither very precise nor universally applicable as a definition of insurance because it describes many other arrangements and relationships which almost uniformly are not regarded or treated as insurance transaction.’ The same view was taken in Arizona where it was held in Guaranteed Warranty Corp Inc v State ex rel Humphrey 23 Ariz App 327 (1975) that a ‘warranty agreement’ was an insurance contract where it involved a firm, which neither made nor retailed television sets, promising to replace the tube if it failed as a result of a manufacturing defect manifesting itself after the expiration of the manufacturer’s warranty. However, a different conclusion was reached in Ohio in another case involving Griffin Systems: [124] Griffin Systems, Inc v Ohio Department of Insurance 575 NE 2d 803 (Ohio Supreme Court, 1991) Sweeney J: ‘In our view, the crucial factor in determining whether a contract is a warranty or something substantially amounting to insurance is not the status of the party offering or selling the warranty, but rather the type of coverage promised within the four corners of the contract itself. Under the rule of law announced in both Duffy [State, ex rel Duffy v Western Auto Supply Co (1938) 16 NE 2d 256] and Herbert [State, ex rel Herbert v Standard Oil Co (1941) 35 NE 2d 437], it is clear that warranties that cover only defects

within the product itself are properly characterised as warranties (as was the case in Herbert, above), whereas warranties promising to cover damages or losses unrelated to defects within the product itself are, by definition, contracts substantially amounting to insurance (as was the case in Duffy, above). The fact that appellant herein is not the manufacturer, supplier, or seller of the products it purports to warrant is, in our view, of little or no consequence in determining whether its protection plans are subject to RC Title 39 [the relevant regulatory provisions]. Common experience in today’s marketplace indicates that a large number of consumer products carry a short-term warranty, but that agreements that extend the warranty beyond the period of time offered by the manufacturer may often be purchased for additional consideration. Certainly, it can be safely surmised that most people are not induced to buy a specific product based upon an extended warranty agreements that may be purchased at an extra cost. Carrying ODI’s to their logical extreme, however, a seller of consumer products can offer such extended warranties to cover losses or damages, while independent third parties would be subject to insurance regulations even if the extended warranties specifically exclude losses or damages unrelated to defects in the product. Under such circumstances, we reject the statusdeterminative approach urged by ODI and adopted by the appellate court below, in favour of the substance-of-thecontract approach by appellant. Such a substance-of-thecontract approach was implemented by the court in Mein v United States Car Testing Co (1961), App 145, 20 O.O.2d 242, 184 NE2d 489, and is abundantly more consonant with the law and analysis set forth in both Duffy, above, and Herbert, above. Therefore, based on all the foregoing, we hold that a motor vehicle agreement which promises to compensate the promisee for repairs necessitated by mechanical breakdown

resulting exclusively from failure due to defects in the motor vehicle parts does not constitute a contract ‘substantially amounting to insurance’ within the purview of RC 3905.42. Accordingly, the judgment of the court of appeals is hereby reversed.’

Wright J: [dissenting from the view of the majority, argued that the status of the company providing the ‘warranty’ was relevant and that this distinguished the present case from the decision in cases like Herbert, where the manufacturer or the seller of a product gave the warranty.] ‘Griffin can hardly be likened to a manufacturer, supplier or seller offering an extended warranty on one of its products. As stated above, Griffin is clearly not involved in the manufacture or sale of automobiles, and has no control over the risk of defects in those products. It is an independent, for-profit entity offering a contract insuring against the risk of mechanical breakdown of a motor vehicle — an insurable interest. Griffin, for consideration of a stated premium from the policyholder, assumes the risk of certain specified losses and presumably distributes that risk among a larger group of persons bearing similar risks. This case does not involve a warranty because a warranty is a statement of representation made by the seller or manufacturer of goods contemporaneously with and as a part of the contract of sale.’

In R v Anderson & Teskey [1941] 1 DLR 346 (Alberta Supreme Court, Appellate Division) it was held that an automobile club was providing insurance when it contracted with motorists to provide their defence and obtain bail if charged with manslaughter, to provide counsel in a damage action by or against

them arising from motoring, and to indemnify them against certain towing and repair costs. The court decided that the members made payments in return for the right to assistance on the happening of an uncertain event. That this is also the position in England would follow from the decision in Department of Trade and Industry v St. Christopher Motorists’ Association Ltd [1974] 1 WLR 99, and, although the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001, para 12, means those who provide such services are not subject to statutory regulation, the contracts they make are subject to the other incidences of insurance contracts, such as the duty of disclosure. Contrast these decisions with the ruling in Transportation Guarantee Co v Jellins 174 P2d 625 (California, 1946), where a truck maintenance contract, in which one party agreed to do whatever work was required to keep two trucks on the road, was held not to be insurance because, even though it involved a shifting of risk from the truck owner to the mechanic, at its root the contract was about the supply of labour; or, alternatively, the court saw the obligations as analogous to those undertaken by the lessor of vehicles and felt disinclined to see all such contracts as insurance for the purposes of regulation. [125] FSA, The Authorisation Manual: Consultation on Draft Guidance on the Identification of Contracts of Insurance,

Consultation 2002

Paper

150,

London:

FSA,

‘Example 3: manufacturers’ and retailers’ warranties. 1.7.6 Under a simple manufacturer’s or retailer’s warranty the purchase price of the goods includes an amount, in consideration of which the manufacturer undertakes to respond (without further expense to the purchaser) to specified defects in the product, that emerge within a defined time after purchase. Such arrangements may appear potentially to fall within the general description of a contract of insurance: 1.3.4 G. Repairs or replacement products are provided in response to a defined event (the emergence of a latent defect in the product), which is adverse to the interests of the purchaser and the occurrence of which is uncertain. 1.7.7 The FSA has concluded that certain contracts of this kind are nonetheless not insurance, where the warranty is a consequence of the contract of sale, under which the substance of the provider’s obligation is the sale of goods that meet the required (often statutory) quality standard, not the provision of insurance (1.5.2 G (2)). In this situation, the warranty does not involve a transfer of risk, but a recognition (and crystallisation) of an existing responsibility. Example 4: separate warranty transactions. 1.7.8 Sometimes, similar warranties (or warranties for an extended period) are not provided as an inherent part of the purchase, but as a separate transaction, usually with a separate consideration. 1.7.9 The FSA’s approach is to classify contracts of this kind as insurance if, in substance, in return for the customer’s payment, risk is transferred to the

provider. Whether there is a transfer of risk depends on the facts of the case. 1.7.10 In general, therefore, an extended warranty, sold as a separate product, for a separate premium, containing terms which would have constituted insurance if they had been agreed outside the context of the sale of goods, will constitute insurance even though it is agreed in the context of a sale. Here, it is harder to argue that the substance of the transaction is the sale of goods, rather than the provision of insurance. (1.5.2 G) 1.7.11 If the provider is a third party, this will usually be conclusive of the fact that there are different transactions and a transfer of risk. 1.7.12 These considerations apply where, for example, a car dealer provides a third party warranty along with a car. Such warranties generally are insurance based because there is a separate commitment undertaken by a third party provider who accepts the risk and receives a separate premium for it.’

1.8 Is There a Definition?

Need

for

a

General

It might be suggested that the reason why Channel J’s judgment dominates the discussion of the definition of insurance is that he has had the field to himself because other judges have recognised the impossibility of the task. One obvious difficulty with relying on his approach is that it depicts insurance law as a branch of contract law and this is problematic in view of the development of statutory welfare insurance schemes, compulsory insurance,

such as is required by motorists and employers, and schemes, such as the Motor Insurers’ Bureau agreements in England, designed to deal with the situation where the loss results from an uninsured or untraceable driver. Leaving aside the advance of social insurance, the effort to provide a general definition of an insurance contract seems ultimately doomed because it tends to be either too broad or too narrow. Often judges seem constricted by their obligation to acknowledge Channel J’s definition, but they are also reluctant to allow it to lead them to an unpalatable conclusion. The question of whether a particular agreement is insurance tends to arise only in the context of regulation, and then it is a matter of whether the alleged insurer should be subject to regulation as being someone who is engaged in insurance business. This is very different from determining whether a particular agreement is an insurance contract. In fact, parties to an insurance contract who are disputing their rights and obligations rarely put in issue whether the agreement does indeed amount to an insurance contract. This is because either none of the parties raises the matter or because the dispute can be settled according to the general rules of contract so there is no need to decide whether the special rules relating to insurance contracts apply. This means that a transaction could be insurance business for the purpose of regulation, but not an insurance contract for the application of rules such as the duty of disclosure and subrogation, or vice versa.

[126] RE Keeton and AI Widiss (Insurance Law: A Guide to Fundamental Principles, Legal Doctrines, and Commercial Practices (West Publishing, St Paul, Minn, 1988) at 3–5 ‘An insurance contract generally involves an agreement by which one party (usually identified as an insurer) is committed to do something which is of value for another party (usually identified as an insured or a beneficiary) upon the occurrence of some specified contingency. In most litigation involving this type of contractual arrangement, attorneys do not need to address issues that involve the definition of what constitutes insurance either (1) because there is a generally shared assumption that the transaction in question is insurance, or (2) because it makes no difference to the resolution of the dispute whether the contractual commitments involved in the litigation constitute an insurance transaction since the issue will be resolved in accordance with general principles of contracts, property, torts, or restitution. Occasionally, however, legal consequences either are determined or are influenced by whether a particular contractual relationship is an insurance transaction. When it is essential to decide whether a transaction involves insurance, neither the characterisations of the parties in the contract (that is, whether the parties are explicitly identified as insurer and insured, by some other comparable nomenclature, or by terms that bear no relationship to such designations) nor the fact that one party is committed to do something upon the occurrence of a specified contingency for the other party, will necessarily dictate the resolution of a dispute about the nature of the arrangement at issue. Similarly, recognition that a particular contractual arrangement involves the transfer and

distribution of risk generally is not sufficient to answer the question. Although risk transference and risk distribution are among the basic characteristics of almost all insurance transactions, the resolution of a dispute about what constitutes insurance usually is predicated on additional factors or considerations. It is, perhaps, quite natural to anticipate that a definition of insurance would be provided at the beginning of a text on insurance law. There are several reasons, in addition to the problems described in the preceding paragraphs, for not setting forth a definition in this section. First, the question “What is insurance?” arises in many different contexts. Not only are the purposes for which definitions of insurance are sought diverse, but the socio-economic and other factors that influence the definition often differ substantially from one situation to the next. Consequently, the appropriateness of a particular characterisation usually depends on the reason why a definition is needed. For example, the definition of insurance that is either explicit or implicit for purposes of the statutes regulating entities engaged in an insurance business may be quite different from the definition of insurance used in an estate tax law concerned with determining whether it is appropriate to tax payments made to a beneficiary. There is no single conception of insurance that is universally applicable for use in disputes involving questions of law. Furthermore, in a particular jurisdiction the applicable definition of insurance may also be significantly influenced by legislative actions and, in some instances, prior judicial decisions. Accordingly, in the process of selecting or framing an appropriate response to a definitional question, an essential first step for a lawyer is to ascertain both the reasons why the issue arises and the legislative provisions or judicial precedents which may be relevant to the resolution of the question.

Another reason for not attempting to provide a definition of insurance at the beginning of this text is that in order to understand fully the meaning of insurance in any particular context, it is very useful and perhaps necessary — both to be aware of several fundamental insurance principles and to appreciate the basic nature of the business of insurance. In other words, mastery of a certain amount of insurance law and familiarity with some insurance business practices is essential to a comprehension of the problems entailed in perceiving both the characteristics of and limitations on what may constitute appropriate definitions of either insurance or an insurance transaction for purposes of a matter being considered in connection with a question of law. It should also be recognised that the definitions of insurance employed to resolve disputes in various contexts may change as human ingenuity produces innovations which in turn may create a need to revise or modify then existing legal doctrines or definitions. Furthermore, such new concepts may then be applied to older types of transactions as well. In a complex commercial society, it is both appropriate and desirable that insurance concepts, including definitions of insurance, remain flexible enough to be adapted to changing and differing circumstances rather than being so rigid that they become shackles to thought, expression, or innovation. Accordingly, it is important to appreciate (1) that the concept of insurance for purposes of legal analysis is neither fixed nor universal, (2) that a definition of insurance often needs to be formulated for or adapted to the specific circumstances, (3) that a comprehensive understanding of the circumstances in which an issue arises is essential when addressing a definitional question, and (4) that an appreciation of the socio-economic significance of a particular transaction is often critical to determining what will constitute an appropriate definition of insurance. In

other words, a complete answer to the question “What is insurance?” would be, in Learned Hand’s phrase, “mythically prolix, and fantastically impractical.”(Sinram v Pennsylvania RR, 61 F2d 767 at p 771 (2d Cir 1932)).’

1.9 Compensation for Accidents In England, as is the case in most common law jurisdictions, the victim of an accident must seek redress through the law of tort. Indeed, the underlying rationale of tort and of negligence in particular is to compensate victims of wrongs. This is achieved through loss shifting whereby the defendant bears the whole loss that foreseeably flows from his or her wrongful act which has resulted in harm to the claimant (or, in cases of contributory negligence, he or she shares the loss). As its name suggests, negligence is fault based and the claimant will recover to the full extent of his or her loss if it is proved that the defendant’s conduct fell below the requisite standard of care. The compensatory objective of tort is reinforced by legislation that requires certain types of activity to be underwritten by insurance so that in the event of an accident causing harm to a claimant there are sufficient funds available to satisfy a judgment. Thus, it is compulsory for employers and drivers of motor vehicles to have liability insurance covering certain risks arising from their activities. In effect insurance operates to distribute or spread losses amongst those engaged in similar classes of activity who pay premiums to

insurers. An insured defendant thus has the guarantee of his or her insurers to meet any award made by a court for insured losses. The benefit to the victim is that he or she does not run the risk of having a damage award frustrated through the impecuniosity of a defendant. As will be seen in chapter 12, insurance also has a significant impact on litigation because of the insurers’ right of subrogation whereby an insurer can assume control over the proceedings in the insured’s name. It should also be borne in mind that losses are distributed through the social security system. The accident victim may be supported by the state where, for example, the injuries suffered are such as to render him or her unable to work. In broad terms about 50 per cent of the total sum awarded for personal injury or death comes from social security and around 25 per cent from the tort system (see Hazel Genn, Paths to Justice: What People Do and Think About Going to Law (Oxford, Hart Publishing, 1999); and Donald Harris et al, Compensation and Support for Illness and Injury (Oxford, Clarendon Press, 1984)). Tort as the basic means for accident compensation has been criticised as being expensive to administer, inefficient, particularly in terms of the time litigation takes and the toll it takes on the parties, and unfair (see further, DR Howarth and JA Sullivan, Hepple, Howarth & Matthews Tort: Cases & Materials (London, Butterworths, 2000) chapters 1 and 19, and the sources extracted therein). Some of those who have called for reform have questioned whether the tort-

based system should be replaced with a social security scheme whereby the state, in effect, operates as insurer. Of particular note in this regard is Atiyah and Cane who argue that a single comprehensive social security system should replace tort as the basis of compensation. [127] Peter Cane, Atiyah’s Accidents, Compensation and the Law (London, Butterworths, 1999), ch 19 THE WAY AHEAD A social welfare solution In the third edition of this book it was argued that what was needed was a single comprehensive system for assisting the disabled, based on the existing social security system, but with benefits as large as society can afford. In particular, it was suggested that the most practicable and desirable direction of movement was the progressive abolition of tort actions for personal injury accompanied by a gradual extension of the industrial injuries scheme, with any necessary modifications, first to all accidents, and ultimately to disease and illness, whether caused by human action or the result of natural causes. The main argument in favour of such a comprehensive scheme lies in the unfairness produced by lack of integration of the various presently existing schemes for assisting the disabled. Not only is the element of overcompensation which overlap of systems creates a waste of resources, but it is indefensible to compensate some people twice over while others go without any compensation at all. For example, how can we justify paying compensation twice over to a person who loses an eye in an industrial accident merely for the disability itself, while we refuse any

compensation for the disability itself to a person who is blinded by a disease resulting from natural causes? How can we justify giving social security benefits to people who continue to receive full wages while they are off sick when the level of long-term sickness benefits is still so low? Then there is the difficulty of justifying payments made under one system but refused by another. How can we justify giving damages for loss of support to a young childless widow, for example, when the social security system provides no assistance at all to a childless widow under 45 unless she is destitute or incapable of work. Surely society must decide whether it thinks a widow is entitled to support irrespective of her capacity for work, and regulate its compensation systems accordingly. Finally, there is the whole problem of justifying the various preferences in favour of particular groups of disabled people embodied in the present set-up. On the other hand, it must be admitted that t here are very considerable difficulties facing the sort of comprehensive reform being suggested. In the first place, it has been argued that the adoption by the EC of the Directive on Product Liability, which requires Member States to provide citizens ns with a remedy in tort, and which was implemented in Part 1 of the Consumer Protection Act 1987, would prevent a UK government introducing any personal it injuries compensation scheme which involved the abolition of tort actions for victims of injuries falling within the terms of the Directive; or even a scheme which provided victims of such injuries with an entitlement to non-tort compensation in addition to the remedy required by the Directive If the argument is correct, then the more tort-based remedies which the EC requires Members States to provide for their citizens, the more difficult it becomes for any Member State to reform its law of personal injuries in a comprehensive way.

Secondly, the sort of proposal made in the third edition of this book assumes that the disabled should be treated as a separate group within the social security system not only in respect of the special needs of the disabled as contrasted with the able bodied, but more generally. This assumption may not go unchallenged. Even if it were universally accepted, it remains the fact that the disability income system is extraordinarily complex, and the project of reforming it in a comprehensive way would he very difficult, time-consuming and expensive. The fragmented nature of the proposals made by the Pearson Commission perhaps provides a warning against being too optimistic about the prospects for cot comprehensive reform. Nevertheless, the fact that a comprehensive accident scheme has been in operation in New Zealand since 1974, and that a national scheme covering disease and illness as well as accidents reached the stage of draft legislation in Australia before being shelved after a change of government, shows that given vision and energy, plus a determination that broad principles should not he swamped by a mass of detail, a comprehensive scheme of assistance for the disabled need not be unattainable. Another major obstacle in the way of comprehensive reform is the inevitable opposition from special interest groups which, naturally, seek the preservation of schemes, arrangements and preferences which benefit them. One of the important arguments in favour of comprehensive reform is that justice requires that people with similar needs should receive similar assistance. But justice is a very slippery concept, and it is possible to make an argument based on a more or less plausible concept of justice, in favour of many of the preferences for particular groups embodied in the present law. So comprehensive reform requires a firm adherence to a particular notion of social justice, and the political will to disregard the pleas of those who receive special treatment under present arrangements. Recent

history does not give much cause for optimism on this score. But the importance of standing firm is clear when one remembers that only a very small proportion of disabled people benefits from especially generous schemes. A related difficulty is that experience suggests that in a democratic system, large scale reform is, on the whole, harder to effect than small-scale or incremental change. This is no doubt one reason why, in the past, pressure groups have been able to secure the enactment of specific preferential schemes (such as those to compensate vaccinedamaged children and people infected with HIV from contaminated blood products). Since any reformer must accept the realities of the political process, there may be an argument for aiming at comprehensive reform via limited reform — the development of more and more special schemes might generate pressure for rationalisation into a comprehensive scheme; or, alternatively, special schemes might eventually cover virtually the whole field of disablement. A major argument made against proposals for large-scale reform is that of cost. In the case of some limited reforms, such as no-fault road accident schemes, this objection can be met simply by designing a system which, by effecting various savings and trimming certain benefits slightly, costs no more than the scheme being replaced. Comprehensive reform will almost certainly require some new money because it would involve compensating many disabled persons who receive little or nothing under present arrangements. One of the advantages of reform by extension of a currently existing scheme is that by choosing a scheme (the US) with relatively generous benefits, the end result might be a general upgrading of provision for the disabled. The danger in this course is that the objection of cost might lead to a general downgrading of benefits in the existing scheme before its coverage is extended. There is, then, a basic dilemma facing the comprehensive reformer —

is it better to compensate more people at lower levels, or fewer people at more generous levels? In the end, a compromise is most likely which involves, for example, compensating the more seriously disabled quite generously at the cost of relatively low benefits for those with only minor or short-term disabilities — in this way a large number of the disabled receive some assistance, but the more seriously disabled are relatively better catered for. Crucial to the issue of cost is that of whether the income replacement element of benefits (as opposed to the element designed to meet the special needs of the disabled arising out of their physical condition) is to be flat-rate and means-tested — that is, designed to provide a level of reasonable subsistence; or earnings-related and regardless of means — that is, designed to compensate for income loss. We have seen that income-relation is a basic principle of the New Zealand accident compensation scheme, and those who support special schemes for disabilities identified by cause (eg industrial disabilities) usually argue that those whose disabilities arise from a particular source deserve compensatory benefits, even if social security benefits generally are flat-rate and means-tested. Clearly the cost of an income-related scheme would be much greater than that of a flat-rate scheme, and as a matter of principle it is justifiable to ask to what extent it is the obligation of the state to maintain people in their accustomed way of life, as opposed to providing them with a reasonable floor level of support. It is clear that very few would argue that a staterun system should compensate relative to income, however high that income is. But some reformers would argue that, up to a certain maximum, benefits ought to be incomerelated, at least if the income loss lasts for more than a relatively short time (a qualifying period for income-related benefits would save money, and might encourage rehabilitation).

On the other hand, if the demand for income-relatedness were seen as a major obstacle to comprehensive reform, it might be worthwhile giving more thought to some sort of dual system under which flat-rate means-tested benefits at a reasonable level would be available through the social security system, leaving it to individuals to take out private insurance if they wanted benefits above the state-provided level. A related question concerns the future of tort law. One of the factors which has led reformers to propose earningsrelated benefits is that the tort system provides such benefits (in theory at least) whatever the income of the injured person; and in order to defuse opposition to the abolition of tort it has seemed expedient to provide benefits under the new system broadly comparable to those available under tort. This might suggest that at least some, if not most of the opposition to the introduction of a scheme under which all the disabled received flat-rate income replacement, plus provision for special needs, could be defused by leaving the tort system in existence so as to provide a source of earnings-related benefits for those who wanted them. Such a proposal would avoid some of the criticisms of dual systems noted earlier. Since all the special needs of the disabled would be met by social security, it could not he argued that those most in need (ie the severely disabled) were being relegated to an inferior remedy — their basic needs would be met by the State. It is true that such a dual system would be administratively expensive, but one might expect that the tort system would not be heavily used if the State benefits were reasonable in amount (ideally based on average weekly earnings). On the other hand, such a dual system suffers from what is really a fatal disadvantage. The tort system would provide earnings-related benefits for only a proportion of the disabled, as indeed at the rnoment it only covers a small proportion of the disabled. It would be difficult to justify

special treatment for some of the highearning disabled, when the removal of special treatment is a major justification for comprehensive flat-rate benefits. A much more satisfactory solution would be to abolish tort and leave all high earners to insure themselves for income-related benefits if they wished. Finally, it might be argued that the model for any comprehensive reform should be the non-industrial incapacity benefits scheme rather than the industrial injuries scheme on the basis that provision for compensation for permanent disability, regardless of income loss, is unjustified while so many are without adequate income. Even if there is a genuine public demand for disablement benefits over and above adequate income replacement benefits, there is a strong case for restricting these benefits to serious cases in which the disability threatens to destroy a person’s normal mode of life. The emphasis in a comprehensive disability benefits scheme should be firmly on income replacement and provision for the special needs of the disabled. On the other hand, the fact that the IIS is in some respects more generous than the non-industrial incapacity scheme makes it a desirable starting-point with a view to encouraging the setting of benefits for all the disabled at higher rather than lower levels. Whatever scheme provides the basis for development, better provision should be made than under present arrangements for those who suffer partial loss of earnings, especially in cases of long-term disability. Disability working allowance is not an adequate response to this problem. Given that the present political and economic climate is uncongenial to comprehensive reform, should lawyers support and press for whatever limited reform (such as a road accident scheme or a drug injuries scheme) seems politically feasible? The answer must he ‘yes’. The waste and inefficiencies of the tort system are continuing realities,

and there is only so much that tinkering with the tort system can achieve. Even if all we can realistically hope for is that the funds currently tied up in the tort system as it now operates will be better used, this is enough to justify a limited reform, even at the cost of creating or perpetuating anomalies between road accident victims and other social welfare recipients. And in the process the public mind might be sufficiently weaned off the idea of tort rights and on to the notion of no-fault welfare rights, to lead eventually to more comprehensive reform. A private insurance solution The approach we have been discussing might be thought, at the turn of the twenty-first century, to be anachronistic and unrealistic. Surely there is simply no prospect of reforms which would involve increases in public expenditure and expansion of the social security system. If this is true, what should be done to meet the undeniably strong case for radical reform of die way we as a society deal with compensation for injury and disability? Patrick Atiyah has recently argued that the way ahead lies in ‘the spread of more first party insurance’ [PS Atiyah, The Damages Lottery (Oxford, 1997), ch 8]. As a first move, he would abolish the tort-cum-liability-insurance system in relation to road accidents and replace it with compulsory “first party” insurance paid for by car owners. The insurance would cover not only the car owner but, for instance, passengers in the car and pedestrians injured by it. Coverage would, of course, be on a no-fault basis. The element of compulsion would only extend to coverage for medical expenses and a basic level of income replacement, plus (perhaps) some compensation for non-pecuniary loss in cases of very serious injuries. In relation to all other injuries and diseases theoretically covered by the tort system, Atiyah favours the abolition of

tort liability, and leaving people to buy such insurance as they want to provide protection against risks of personal injury and illness over and above that already provided by the social security and social welfare systems. Given the limited coverage of the tort system (largely confined in practice to injuries suffered on the roads, at work and in hospital), the only context in which this proposal would represent a radical reform are those of medical mishaps and work-related injuries. In the longer term, however, the logic of Atiyah’s position seems to contemplate a possible, gradual replacement of the social security and social welfare system with private, first party insurance arrangements. Those interested in understanding Atiyah’s ideas better are encouraged to read The Damages Lottery. Here I will make just a few comments so as to indicate the differences of opinion between us. First, Atiyah’s reason for dealing with road accidents in a special way seems to be the pragmatic one that the amounts currently spent on compulsory third party liability insurance could easily be switched to first party loss insurance. Even in the case of the other major areas of the practical operation of the tort system — work injuries and medical mishaps — the mechanism of change would not be so obvious or straightforward because at present, neither workers nor patients generally take out insurance to cover work injuries or medical mishaps respectively. However, there is no good reason of principle why injuries caused in road accidents should receive different treatment from injuries caused in any other way. A second reservation about Atiyah’s approach concerns its voluntary nature. It is only in the context of road accidents that Atiyah proposes that insurance should be compulsory. But the reason he gives for compulsion — that otherwise “too many people would probably end up without any cover” — applies as much to other contexts as well. Under a voluntary system, the people least likely to be adequately insured are the poor, the ill-educated and the vulnerable.

The protection of such people provides one of the strongest arguments for state provision of social services and social security benefits according to need. Compulsory redistribution of income and wealth from those who are strong, rich and well-educated to those who are less well-off is one of the marks of a humane society. The freedom to be inadequately insured against personal injury and disability is no freedom at all. I certainly support a two-tier system in which cover for losses and expenses above a certain minimum would be voluntary. But up to that minimum level, people should not be left to the vagaries of the “free market”. In my view, there is a strong case for abolishing tort law and the tort system as a mechanism for compensating victims of personal injuries, illness and disability. However, I also believe that the State has an obligation to guarantee an agreed minimum level of support for those in need as a result of suffering injury, illness and disability. This will inevitably involve a certain amount of wealth-redistribution, and probably the simplest way of achieving this is through the tax system. Whether the provision of minimum support is administered by government agencies or private organisation should be decided in terms of who can do the job most efficiently. A final comment: Atiyah says that proposals to replace the tort system by expanding the social security system “now seem hopelessly dated” and politically unrealistic. This may be true; although if it is, there is hardly cause for celebration. What seems equally true to me, at least, is that proposals to abolish the tort system and to replace it and much of the welfare system with voluntary private loss insurance are politically naive and ethically problematic.’

Note:

1. As pointed out by Atiyah, a model for a no-fault regime can be found in New Zealand which has replaced the mixed system of common law damages, social security, workers compensation schemes, and third party liability insurance with a comprehensive accident compensation scheme. The New Zealand reforms came about as a result of a Royal Commission under the chairmanship of Mr Justice Woodhouse (The Woodhouse Report on Compensation for Personal Injury (December 1967)) which recommended no-fault benefits for accidental injury covering: — all motor vehicle injuries, funded by a levy on owners of motor vehicles and drivers — all injuries to earners whether occurring at work or not, funded by a flat-rate levy on employers for the cost of all injuries to their employees and a levy on selfemployed persons to pay for injuries occurring at work or outside of work 2. Thus, the right to sue for injuries resulting from motor vehicle accidents would be removed. Employers would have to pay a compulsory levy for injuries to employees but in return they would also be protected from being sued for damages. The right to sue for non-work injuries to earners would also be removed. The Woodhouse Report recommended that the scheme should be based on five principles:

(i) community responsibility (ii) comprehensive entitlement (iii) complete rehabilitation (iv) real compensation (v) administrative efficiency 3.

The Accident Compensation Act 1972 implemented the Report’s recommendations. An amending statute passed in 1973, following a change of government, provided for a supplementary scheme, funded by the Government, covering students, non-earners and visitors to New Zealand. The scheme came into effect on 1 April 1974 and is administered by the Accident Compensation Commission (ACC). Benefits include: — — — — —

hospital and medical expenses rehabilitation costs associated transport costs earnings related compensation lump sum payments for permanent loss or impairment — lump sum payments for pain and mental suffering — funeral costs and lump sum payments to surviving spouses and children in cases of accidental death In return people do not have the right to sue for personal injury other than for exemplary damages. In essence, the scheme amounts to state

comprehensive insurance given that all New Zealanders pay premiums for ACC cover, the levels of which are set by the government. In total the ACC spends around NZ$1.4 billion each year on rehabilitation, treatment and weekly compensation. Over the years various changes to the scheme were made in an attempt to rein in costs and in 1992 lump sum payments were abolished (see the Accident Rehabilitation and Compensation Insurance Act 1992). However, the Injury Prevention Rehabilitation and Compensation Act 2001 reintroduced lump sum payments and provided for greater focus on accident prevention as the primary function of the ACC.

2 Regulation of Insurers This chapter does not seek to provide detailed coverage of the authorisation and supervision of insurers in the UK. Instead, the aim is to look at regulation in terms of its objectives and of the broad approach taken by the regulator, the Financial Services Authority.

2.1 Objectives of Regulation The regulation of financial institutions began in most developed economies in the nineteenth century, typically in response to particular crises in particular parts of the industry. That pattern continued in most countries until relatively recently when multifunctional financial institutions (eg insurance companies opening banks) made it increasingly difficult to sustain regulatory structures that divided along functional lines (insurance, banking, securities and so forth). This has led some countries, such as the UK, to adopt unified regulatory structures. In addition, the growth of financial institutions that conduct business in countries other than the one in which they are established and the interconnection of

national financial markets has posed problems for a regulatory approach directed by national regulators. However, recently there have been efforts, both within regions (eg the European Union) and globally (eg the International Association of Insurance Supervisors) to develop common approaches. There remain the problems of why regulation of insurance is needed and what it should seek to achieve. [201] S L Kimball, “The Purpose of Insurance Regulation: A Preliminary Inquiry into the Theory of Insurance Law” [1961] 45 Minnesota Law Review 471 ‘In the United States and Germany, and to a lesser but considerable extent in many other countries, insurance is subject to close regulation. Interference with free activity in the insurance market is especially noteworthy in a business which is highly competitive, which is generally well-run along conservative lines, and which presents no striking problems of domination of economic life or subversion of political processes. It is perhaps not easy to justify such extensive regulation, at least in comparison with the freedom enjoyed by most other businesses of similar importance. If one seeks reasons, he is told that the parties to an insurance contract are not negotiators of equal weight in the marketplace, that insurance is an exceedingly complicated business selling a product which is difficult for its votaries to understand and impossible for most of its buyers, that the contract has long duration in many instances, that the uncertain payment coming at the end of the long delay is likely to be of crucial importance in the life of the policyholder. Although all of these things are true, it

must be conceded that each of them is true of some other businesses as well. However, there is probably no other business to which so many of these characteristics apply in such large measure, and perhaps in the aggregate these factors justify the deep-probing supervisory activities of the modern insurance department. All of these factors are in reality variations of the first, the disparity in bargaining power. This suggests that regulation exists to protect the weaker contracting party. It is not surprising, therefore, that marine and transport insurance and reinsurance have generally been subjected to much less control than other lines of insurance, for here the insurance buyer is likely to be as large as the seller, as expert, and as adept in the market-place. While protection of the weaker of two contracting parties explains the intervention of the state in the insurance transaction, it does not explain the myriad forms taken by that intervention. Beginning with the most obvious, the requirement of solidity [by which is meant, broadly, solvency] is imposed because without it the business does not work at all, does not insure. This purpose is the first to be perceived after the decision has been made for government intervention; indeed, threats to solidity were the raison-d’être of the early insurance departments. Once intervention has begun, new purposes begin to emerge, and the goals of reasonableness, equity, and fairness become explicit. Finally, as the insurance enterprise becomes more and more crucial to the social fabric and as regulation acquires more sophistication, the manifold purposes of society at large come to have more and more implications for the processes of insurance regulation. There is nothing inevitable about the growth of insurance regulation from a simple focus on the solidity of the enterprise to a wide-ranging concern for many purposes. English regulation, for example, seems to have gone little beyond the purpose of solidity. Clearly, in the case of

England this reflects neither an undeveloped state of the insurance enterprise nor an undeveloped sense of responsibility for the welfare of the people. In part it reflects a greater emphasis than we place on certain of the objectives we have described, for the objectives are not all consistent with one another. In part it may reflect also an entirely different pattern of solutions which seek and achieve roughly the same ends. Thus the ease of access of new entrepreneurs into the American insurance market presents the American insurance departments with difficult problems of control — problems that do not exist in the English market, where few new companies are formed. Moreover, there is said to be a quality of sober restraint in English economic life that may make various kinds of regulation less necessary than here. Another relevant factor is the degree of self-regulation of the business. One may justifiably suggest as a hypothesis that the English pattern of regulation seeks the same goals as the American, but that the English social and governmental structure permits it to achieve the same goals with a lesser expenditure of effort than does ours. This would not be the first time that English society had managed to do a large job with a small investment in central government machinery. In its early centuries, the royal judicial machinery in England operated quite successfully with an investment in judicial manpower that was a mere tithe of that used on the continent of Europe. Before one concludes that the English are less effective in achieving most of the goals we have described, or are uninterested in some of them, one needs to make a close comparison between the English insurance system and the American or German systems — and in considerable depth. The differences one thinks he perceives between the purposes of English insurance supervision and those of either American or German supervision may be more apparent than real. The difference may instead be a difference in the extent of the need for particular

governmental controls. But this question requires much exploration before one can venture an answer. It is usually assumed that the purpose of insurance regulation is single and simple. In reality it is neither. There are many purposes, and they are in considerable conflict with one another. Insurance is a small world that reflects the purposes of the larger world outside it. It is not easy, therefore, to state a theory of insurance regulation in which every activity will neatly fit. Perhaps it is even impossible. It seems likely, however, that more attention directed to the purposes of insurance regulation would illuminate the field and render it more meaningful, not by making it simple but by explaining the objectives in all of their complex interaction and in all of their conflict. Only thus can a theory of insurance regulation be developed as a meaningful guide to practical, everyday activities in the insurance departments of the world.’

Note: Kimball goes on to suggest that the objectives of insurance can be divided into those that ‘relate to the internal working of the insurance business and those that derive primarily from its relationships to the world outside.’ He emphasises solidity or solvency within the first category, but also includes what he terms ‘aequum et bonum’. This latter ‘has many facets: It is equity. It is morality. It is fairness, equality, reasonableness. It may even be efficiency, economy, parsimony.’ More particularly, he refers to issues, which have been a feature of regulation in the US, such as reasonable premium rates and policy terms for all policyholders, no discrimination against particular groups of policyholders and fairness in the

treatment of individual policyholders. Among the objectives that Kimball identifies as not inherent in the insurance business, he mentions corporate governance, controls over the regulatory authorities and policies that subject foreign insurers to disadvantages in relation to domestic insurers. Objectives in this second category are drawn from the fact that, ‘Insurance does not exist in a vacuum, but in a complex modern society with a developed and dynamic economy.’ There is, for instance, pressure to broaden coverage as exemplified by the emergence of workmen’s compensation, compulsory motor insurance and so forth. He also points out that the free market principle means there is pressure to allow new insurers. Finally, there are moral considerations, such as have led to laws on gaming. [202] J Hellner, “The Scope of Insurance Regulation: What is Insurance for the Purposes of Regulation” (1963) 12 American Journal of Comparative Law 494 ‘At the opposite extreme from using the definitions as a guide in delimiting the scope of regulation, there is the possibility of simply asking whether there is need for regulation or not…The reasons for submitting certain activity to regulation coincide mainly with the general reasons for supervising insurance. Although these reasons are not identical for all countries, as appears from fact that the rules and facts of supervision differ considerably one country to another, some main reasons can be stated. They include the need for protection against fraud, the need for technical skill and caution in conducting a sound insurance

business, the need to collect and protect adequate funds (most conspicuous in long-term insurance, such as life insurance), the general desire to assure a fair and equitable treatment of the insured, the need to protect the insured against his own inability to understand the value of what he gets in exchange for the premium, and the great social importance of insurance that has as a principal object the task of providing assistance in time of need. If we accept these reasons for supervising insurance as our primary guide for delimiting regulation, the outcome would differ considerably from that reached by starting from the definitions of insurance. Instead of examining whether there is assumption and distribution of risks, we should ask whether there is a need for a complicated technique which calls for a special skill. Instead of asking whether the promisee gives any special consideration for the promise, corresponding to a premium, we have the question whether the value of the promise is difficult to estimate. Instead of asking whether the risk attaches to a fortuitous event, we should rather ask whether there is a need to collect and maintain special funds. Furthermore, we should ask whether there is any need for protection against fraud and for ensuring fair and equal treatment of the promises, and whether the promise has less social importance. Against using the need for regulation as a test it can, however, be argued that general policy objectives are not suitable means for deciding questions of applicability of law. If we should ask simply whether an activity is in need of regulating, we might conclude that a certain enterprise does not need to be supervised, because it is well managed without supervision. But this would be inconsistent with the policy which imposes regulation even on the best-managed insurance companies. At the other extreme we might impose regulation on any enterprise whose activity calls for accumulation of funds and where the value of the benefits is

hard to estimate. It is necessary to find some more concrete and limited circumstances on which to base the decisions. A more rational use of the idea that regulation should be imposed where there is a need for it consists in deducing from the rules of insurance law those particular dangers to the public an enterprise must create in order to be a legitimate subject for regulation. The decisive factor is not whether the business is well managed in the particular instance but whether the activity is of a type which requires regulation as insurance. If an enterprise operates on the basis of such risk-taking as requires the accumulation of funds, careful rate-making, and holding safe and liquid assets, it presents those dangers that are contemplated and counteracted in the rules of insurance law. If the dangers to the public are only those of usury or of unfair competition, or of deficient performance of professional services, there is no reason for imposing regulation as insurance, even if it may be assumed that as a secondary result of such regulation these deficiencies would also be eliminated. However, this is certainly not the whole solution of the problem. The fact that an enterprise offers dangers that are typical of insurance and counteracted by rules of insurance law does not imply that it must be regulated. To comply in all respects with the rules of regulation — whether these are stated in a statute or depend on the discretion of the supervising authorities — will often be so great a burden that useful activity might be suppressed. We must therefore take into account also those considerations that argue against regulation. We are now back at the same result as was implied in the criticism of the approach through a formal definition; we should examine whether an activity is of such a type that it should conform to well managed insurance. We then do not look at each single feature of the activity separately but consider the whole structure of the business as an entity. This view is also justified by the fact that there is often a

close connection between the relevant aspects of an activity. If an enterprise is simple, unbusinesslike, and provides services in kind rather than in money, there is generally (but not always) little need for the collection and preservation of funds. Instead of comparing the details of the activity one by one with the elements of a definition, we should therefore examine the whole of it on the basis indicated by the insurance laws.’

Note: For other aspects of this problem of defining insurance for the purposes of regulation, see chapter 1.

2.2 Financial Services and Markets Act 2000 Those engaged in insurance business in the UK have been subject to regulation since the Life Assurance Companies Act 1870, which, as its title indicates, was confined to the life assurance industry. Regulation gradually spread to other parts of the industry so that by 1946 the whole sector was covered. However, regulation was limited in its ambition. It addressed concern about the ability of insurers to meet claims as they fell due by requiring them to place money on deposit with the court to ensure the availability of funds should problems over solvency arise. At the same time, the relationship between the insurer and the insured was left to the principles of insurance contract law developed by the courts.

[203] Re North & South Insurance Corp Ltd [1933] 47 Ll L R 346 Maugham J: ‘An insurance company differs in its nature from almost every other trading concern. It starts, in the first instance, without liabilities. It obtains premiums sometimes to very large amounts, and, as risks mature and its debts begin to figure in its balance sheet, premiums which are received ought in general to be set aside for the purposes of paying not only the not unsubstantial costs of carrying on an insurance company business but also the claims which are inevitable. The solvency or insolvency of an insurance company has to be ascertained, as everybody knows, by, among other things, a most careful scrutiny of the funds which have been set aside out of premium income for the purpose of meeting claims. Inasmuch as the claims come in in every case after the premiums have been secured, there is always a risk that an insurance company may, by offering what look like very advantageous terms to the public, obtain a very large premium income which, as the result of the practical working of the company, proves to be an insufficient income for the purpose of meeting claims.’

Note: The Insurance Companies Act 1982 emerged against a background of scandals in the insurance industry and progress towards the creation of the European single market in financial services. The UK sought to establish a more comprehensive system of prudential supervision under which the financial health of insurers would be monitored by the Secretary of State for Trade and Industry. In addition, from 1975

insureds were given some financial protection against the consequences of an insurer failing. The marketing of those insurance contracts that involved investment was regulated under the Financial Services Act 1986, and there was also regulation of brokers (see chapter 3). On the eve of the election of the Labour Government in 1997 there remained much cause for anxiety about insurance regulation. Major insurers were being punished for the actions of their agents in misselling private pensions and there were also problems over the performance of endowment insurance policies that had been sold to homeowners as a means of repaying mortgages. More generally, the supervision of the financial sector was regarded as too complex. As has been mentioned, the method employed was to divide the industry according to the function of the firms being supervised: banking, insurance, investment advisors, fund managers and so forth. Each of these sub-sectors had its own supervisor. One problem was that the major financial institutions were rapidly spreading their business across these sectors: insurance companies were moving into retail banking and banks were selling insurance. This meant that a single firm could be policed by several regulators. After the 1997 election the Labour Government announced that supervision of most of the financial sector, which had been conducted by ten regulators, would be transferred to the Financial Services Authority (‘the FSA’). The Financial Services and Markets Act 2000 (‘FSMA’), which came into effect in

the following year, provides the legal framework within which this new system operates, but that framework was deliberately made fairly loose to allow the FSA flexibility. The FSA took on responsibility for both prudential supervision, which, broadly, relates to the stability of firms and the financial system, and conduct of business, which concerns the way authorised firms deal with customers. Although the wisdom of combining these two issues was questioned, its value seemed to be confirmed by the problems with a major life insurance company, Equitable Life. Under the system that prevailed when the company got into difficulties over promises it had made to investors, prudential supervision and conduct of business were handled by different regulators and, as the Parliamentary Commissioner for Administration pointed out, the supervisors saw the same set of facts in completely different ways (see Parliamentary Commissioner for Administration, The Prudential Regulation of Equitable Life, 4th Report, HC 809 (sess 2002–03)). The Commissioner’s report also highlighted another, more intractable problem in the mismatch between the powers of the regulators and the expectations of investors. As will be seen, since FSMA the FSA has emphasised that it does not seek to ensure that no companies fail and that it has a statutory obligation to educate investors about, among other things, the risks involved in investment. The approach taken by the Act was radical in another way. Instead of focusing on the risk exposures of individual firms, the Act laid down

objectives (s 2(2)) which the FSA was required to achieve, subject to the principles of good regulation set out in section 2(3). The FSA, therefore, developed what it has called the ‘risk-to-our objectives’ approach. In essence, this focuses on the risk posed to the statutory objectives by a firm. At the same time, all firms are expected to be soundly managed and well resourced. The approach taken by the FSA is elaborated in its Handbook, which, although a vast document, at least has the merit of being clearly written. [204] Financial Services Authority, The Future Regulation of Insurance: A Progress Report (London, FSA, 2002) ‘1.1 In order to place the regulatory reforms into context, this chapter describes the economic, social and strategic importance of the insurance industry and the present challenges it faces. It then sets out what might be the key characteristics of the insurance market in the future and, finally, it explains the influence our reforms will have in that context. 1.2 The insurance sector is a key part of the UK financial services industry. It is important, both from an economic and a social perspective, that the UK has an insurance market that operates effectively, remains competitive in European and world markets, and in which all participants have confidence. The insurance industry allows consumers, both retail and commercial, to transfer risk, to buy protection and to save (for example, for retirement). An effective savings industry has become all the more important given both the public policy objective to shift

responsibility for retirement provision away from the public purse, and trends in the occupational pensions market towards defined contribution schemes. 1.3 In addition to providing an important service to individual consumers, the insurance industry underpins almost all forms of economic activity and contributes directly and indirectly to wealth generation and social wellbeing. For example, the insurance industry: — enables businesses to pool risks associated with future uncertainties, and to sustain higher levels of activity than they could otherwise. This increases levels of economic activity and reduces costs, assisting UK firms in competing both in domestic and international markets; — allows organisations, both public and private, to ensure that their employees, those who use their products or services and other third parties who may be adversely affected by their operations are protected financially in the event that they suffer injury or loss. In some cases, such protection is required by law; — is a major means through which savings are channelled into investment in industry (the life industry accounts for about 20 per cent of shareholdings in UK industry). Through these investments, the industry helps drive growth across the whole economy; and — is a major direct contributor to UK GDP and foreign earnings and is a major source of employment.’

[205] Howard Davies (Chair of the FSA), “Speech to the Annual Meeting of the Financial Services Authority” (London, FSA, 2003)

‘In the UK market the boundaries between financial services are becoming increasingly blurred. This is particularly evident in relation to life insurance, but in non-life insurance alternative forms of risk transfer and securitisation of risk are also developing. Add to this the formation of complex groups and conglomerates — amongst other things to exploit market opportunities for cross selling — and the interactions between insurance and other financial services are clearly growing. The establishment of the FSA was not a case of the regulators leading the market, but of the Government recognising that developments in the market required a more co-ordinated approach to supervision across financial services.’

[206] International Monetary Fund, United Kingdom: Financial System Stability Assessment, Country Report 03/46 (Washington DC, IMF, 2003) ‘VII. IAIS INSURANCE CORE PRINCIPLES Institutional and macroprudential setting 157. The British insurance industry is venerable and large, contributing importantly to UK employment and overseas earnings. With net premium income in 2000 of £174 billion or approximately 10 per cent of the world market, it is the third largest after the US and Japan (although considerably smaller than either). It includes the most important cross border non-life insurance markets in Lloyds and the London Market, which together account for 65 per cent of approximately US $20 billion of annual global cross border general insurance premium flows…and is a significant source of life insurance product for people resident in other EU countries. Insurance penetration at 15.8 per cent is the

highest in the world, South Africa excepted. UK insurers are also well represented in foreign markets. 158. UK based insurers are, with self-administered pension funds, the most important repositories of individual financial sector wealth. Of total FY2000 financial assets of households and related non-profits of £3 trillion, more than 50 per cent is represented by insurance policyholder-related liabilities…Total investment assets under management at the end of 1999 amounted to slightly over £I trillion and the life and pensions sectors were easily the major providers of finance to government and private borrowers. 159. An analysis of the long term (life) insurers by capital strength shows a distinct bimodal distribution, with a large number of insurers having 100 per cent to 300 per cent of minimum required statutory solvency and a smaller, but significant group of very well capitalised insurers. From a stability and efficiency point of view the main danger is that if investment returns remain depressed, some long term players under stress will engage in risky business and investment strategies and tactics in an attempt to improve their market positions. This has already been observed in a number of other leading industrial markets, and FSA management has advised that they are aware of and monitoring this trend. 160. The general insurance industry does not face fundamental questions of the type facing the long term sector; however it does have its own challenges. These relate largely to operating in a world of low investment returns, much fatter and less tractable claims tails than were previously thought to exist and, in the near future, a more demanding recognition of liabilities and capital allocation under a risk based prudential regime. 161. Overall the assessors did not identify any immediate systemic risks arising from the insurance sector.

However the linkages between insurance and banking appear to be growing and warrant close monitoring. Broader risks arising from the potential rationing of insurance classes essential to the operation of key sections of the economy also appear to be low, but the assessors were advised that if the general insurance sector suffers additional severe shocks, this could become an issue. General preconditions for effective insurance supervision 162. The UK…has a well-developed judicial system with a reputation for probity and professionalism. The professions important to the financial sector are also well developed in the UK and are subject to full liability for breach of duty. There is no insurance accounting standard aside from the regulatory reporting requirements, which serve a different role to published accounts. Instead there is a Statement of Reporting Principles (SORP), largely worked out by the insurance sector on a modified regulatory reporting basis, but informed by general company reporting requirements, and “negatively approved” (not objected to) by the Accounting Standards Board (ASB). The assessors were advised that the imposition of IAS [International Accounting Standards] in the EU in 2005 will to a large extent supplant the ASB role. Main findings 163. The UK is developing a very advanced, indeed leading edge, approach to financial sector supervision. The FSA’s approach for the future appears to be to build on existing strengths, but with more focus on risk level and likely macro impact, and further emphasising the responsibilities of management’s and boards of entities which come within its remit. To some extent the

approach cuts across the Core Principles, which incorporate a range of supervisory styles. Nevertheless, the FSA and its supporting regulatory infrastructure comfortably accommodate most requirements of the IAIS assessment methodology. When the importance and special features of the UK market are considered, and appropriately more demanding standards are applied, a number of opportunities for further refinement become apparent. In particular, under the UK risk-based approach, not all financial intermediaries will be inspected (unless they are selected for a thematic investigation), and even in the larger institutions, the more routine supervisory visits will generally operate at a high level, although skilled persons may be utilized when required. The assessors judged that there is scope for a more handson approach to inspection, using specialist skills where appropriate while still not threatening the risk-based model. 164. Insurance supervision in the UK is in a transition phase, and the assessors strongly agree that greater emphasis will need to be placed on staff training and development as the new risk-based methodology is rolled out. In addition, the disposition, quantity and quality of actuarial, non-lifelong tail claims assessment, and reinsurance skills needs to be carefully reviewed with a view to further strengthening. 165. The UK is a world leader in corporate governance; however the assessors recommend that the FSA require firms to strengthen or formally adopt the risk manager function. In addition, there is a general perception that on site inspections by the supervisor could be more testing. The modalities currently being developed should largely deal with these concerns. 166. The assessors believe that there is scope for a more explicit statement of solvency requirements. Regulatory

minimum solvency levels are officially set at EU levels or somewhat higher, which tend to be less demanding than risk based capital methodologies. While the assessors acknowledge that more demanding standards apply in practice in the UK through the informal rules that have been applied, these ideally should be codified…’

Note: By way of contrast, it may be noted that in the USA the McCarran-Ferguson Act 1945 placed regulation of insurance in the hands of the states, although the establishment of multistate and multifunctional financial institutions has provided problems for this regime. As well as being concerned with issues such as capital standards and liquidity, the powers of the regulators stretch beyond those of the FSA into regulating premium rates and policy provisions. See KS Abraham, Cases and Materials: Insurance Law and Regulation (New York, Foundation Press, 2000), ch 3; RW Klein, “Insurance Regulation in Transition” (1995) 62 Journal of Risk and Insurance 363; S Randall, “Insurance Regulation in the United States: Regulatory Federalism and the National Association of Insurance Commissioners” [1999] Florida State University Law Review 626.

2.3 The Roles and Powers of the FSA The FSA has wide-ranging powers and functions:

(i) as a legislator it makes rules, statements of principle, codes of practice, gives directions and issues general guidance (eg see sections 64, 69, 119, 124, 138(1), 141–42, 158(5), 210, 316, 318, 328); (ii) as an investigator it has powers to gather and demand the information required to undertake its work (see, for example, sections 165–77, 284, 340, schedule 15); (ii) as a judicial and enforcement authority it rules on breaches and imposes penalties in the form of fines and the refusal, variation, suspension or withdrawal of authorisation (see, for example, sections 205–11 and below, and Part XXVI); (iii) as a prosecutor with respect to an offence under the Act or subordinate legislation (eg sections 401–02); (v) as a compensatory mechanism it has established a scheme, funded by the industry, to compensate those who have suffered loss in the event of an authorised person being unable to meet claims (sections 212–24). The FSA set up Financial Compensation Scheme, which replaces the Policyholders Protection Fund.

One theme running through the structure of the Act and the FSA’s own procedures is the need for regulatory transparency and accountability. The mechanisms include an independent Complaints Commissioner (FSMA, Sch 1, para 7), the Financial Services Ombudsman Service (FSMA, section 225 and Sch 17, Parts I and II), Practitioner and Consumer Panels, with whom the FSA must consult (FSMA, sections 8–11). There also elaborate provisions for public consultation, which the FSA must undertake before issuing rules, statements or codes (see sections 65, 155). These have led to criticism about delays and paperwork. Moreover, while a person or firm that has been

disciplined by the FSA may seek a fresh hearing before the independent Financial Services and Markets Tribunal, the publicity that may be generated is not likely to be welcomed by the industry. The paucity of hearings before the Tribunal seem to confirm the view expressed by Lord Hodgson during the progress of the bill through the House of Lords: ‘Regulated firms, knowing that there will be publicity whatever the outcome, will inevitably be reluctant to avail themselves of their full legal rights…Even if the defendant is found not guilty, the aura of being so referred will take a long time to dispel…Such recollections would make a significant dent on any firm’s operations for a long time.’ (quoted in A Hayes, “Open Justice at the Tribunal?” [2002] Butterworths Journal of Banking and Financial Law 427)

See R Merkin, ed, Colinvaux & Merkin’s Insurance Contract Law (London, Sweet & Maxwell, 2002). [207] Financial Services and Markets Act 2000 19 (1) No person may carry on a regulated activity in the United Kingdom, or purport to do so, unless he is— (a) an authorised person; or (b) an exempt person

Note: The penalties for breach of this provision (the ‘general prohibition’) are set out in sections 23–24; see also sections 26–28 on the consequences for the enforcement of agreements made with unauthorised

persons. Under section 31(1) an authorised person is one who has ‘a Part IV permission to carry on one or more regulated activities’. Part IV (sections 40–54) provides the broad framework for granting, suspending, varying or withdrawing authorisation, and sets out the rights of those applicants or authorised persons aggrieved by a decision on these matters (section 55). Prudential supervision involves both licensing persons to enter the market and monitoring those who have been authorised. The supervision of Lloyd’s is left in the hands of the Council subject to oversight by the FSA (see sections 314–24 and below, part V). [208] Financial Services and Markets Act 2000 2 (2) The regulatory objectives are— (a) market confidence; (b) public awareness; (c) the protection of consumers; and (d) the reduction of financial crime. (3) In discharging its general functions the Authority must have regard to— (a) the need to use its resources in the most efficient and economic way; (b) the responsibilities of those who manage the affairs of authorised persons; (c) the principle that a burden or restriction which is imposed on a person, or on the carrying on of an activity, should be proportionate to the benefits, considered in general terms, which are expected to result from the imposition of that burden or restriction;

(d)

the desirability of facilitating innovation in connection with regulated activities; (e) the international character of financial services and markets and the desirability of maintaining the competitive position of the United Kingdom; (f) the need to minimise the adverse effects on competition that may arise from anything done in the discharge of those functions; (g) the desirability of facilitating competition between those who are subject to any form of regulation by the Authority. 3 (1) The market confidence objective is: maintaining confidence in the financial system. (2) “The financial system” means the financial system operating in the United Kingdom and includes— (a) financial markets and exchanges; (b) regulated activities; and (c) other activities connected with financial markets and exchanges. 4 (1) The public awareness objective is: promoting public understanding of the financial system. (2) It includes, in particular— (a) promoting awareness of the benefits and risks associated with different kinds of investment or other financial dealing; and (b) the provision of appropriate information and advice. (3) “The financial system” has the same meaning as in section 3. 5 (1) The protection of consumers objective is: securing the appropriate degree of protection for consumers. (2) In considering what degree of protection may be appropriate, the Authority must have regard to— (a) the differing degrees of risk involved in different kinds of investment or other transaction;

(b) the differing degrees of experience and expertise that different consumers may have in relation to different kinds of regulated activity; (c) the needs that consumers may have for advice and accurate information; and (d) the general principle that consumers should take responsibility for their decisions. (3) “Consumers” means persons— (a) who are consumers for the purposes of section 138; or (b) who, in relation to regulated activities carried on otherwise than by authorised persons, would be consumers for those purposes if the activities were carried on by authorised persons. 6 (1) The reduction of financial crime objective is: reducing the extent to which it is possible for a business carried on— (a) by a regulated person, or (b) in contravention of the general prohibition, to be used for a purpose connected with financial crime. (2) In considering that objective the Authority must, in particular, have regard to the desirability of— (a) regulated persons being aware of the risk of their businesses being used in connection with the commission of financial crime; (b) regulated persons taking appropriate measures (in relation to their administration and employment practices, the conduct of transactions by them and otherwise) to prevent financial crime, facilitate its detection and monitor its incidence; (c) regulated persons devoting adequate resources to the matters mentioned in paragraph (b). (3) “Financial crime” includes any offence involving— (a) fraud or dishonesty; (b) misconduct in, or misuse of information relating to, a financial market; or

(c) handling the proceeds of crime. (4) “Offence” includes an act or omission which would be an offence if it had taken place in the United Kingdom. (5) “Regulated person” means an authorised person, a recognised investment exchange or a recognised clearing house. … Part IV Permission to Carry on Regulated Activities 40 (1) An application for permission to carry on one or more regulated activities may be made to the Authority by — (a) an individual; (b) a body corporate; (c) a partnership; or (d) an unincorporated association. (2) An authorised person may not apply for permission under this section if he has a permission— (a) given to him by the Authority under this Part, or (b) having effect as if so given, which is in force. (3) An EEA firm may not apply for permission under this section to carry on a regulated activity which it is, or would be, entitled to carry on in exercise of an EEA right, whether through a United Kingdom branch or by providing services in the United Kingdom. (4) A permission given by the Authority under this Part or having effect as if so given is referred to in this Act as “a Part IV permission”. 41 (1) “The threshold conditions”, in relation to a regulated activity, means the conditions set out in Schedule 6. (2) In giving or varying permission, or imposing or varying any requirement, under this Part the Authority must ensure that the person concerned will satisfy, and continue to satisfy, the threshold conditions in relation to all of the regulated activities for which he has or will have permission.

(3) But the duty imposed by subsection (2) does not prevent the Authority, having due regard to that duty, from taking such steps as it considers are necessary, in relation to a particular authorised person, in order to secure its regulatory objective of the protection of consumers … Schedule 6 Threshold Conditions Part I Part IV Permission Legal status 1 (1) If the regulated activity concerned is the effecting or carrying out of contracts of insurance the authorised person must be a body corporate, a registered friendly society or a member of Lloyd’s. (2) If the person concerned appears to the Authority to be seeking to carry on, or to be carrying on, a regulated activity constituting accepting deposits, it must be— (a) a body corporate; or (b) a partnership.

Location of offices 2(1) If the person concerned is a body corporate constituted under the law of any part of the United Kingdom— (a) its head office, and (b) if it has a registered office, that office, must be in the United Kingdom. (2) If the person concerned has its head office in the United Kingdom but is not a body corporate, it must carry on business in the United Kingdom. Close links 3(1) If the person concerned (“A”) has close links with another person (“CL”) the Authority must be satisfied —

(a) that those links are not likely to prevent the Authority’s effective supervision of A; and (b) if it appears to the Authority that CL is subject to the laws, regulations or administrative provisions of a territory which is not an EEA State (“the foreign provisions”), that neither the foreign provisions, nor any deficiency in their enforcement, would prevent the Authority’s effective supervision of A. (2) A has close links with CL if— (a) CL is a parent undertaking of A; (b) CL is a subsidiary undertaking of A; (c) CL is a parent undertaking of a subsidiary undertaking of A; (d) CL is a subsidiary undertaking of a parent undertaking of A; (e) CL owns or controls 20% or more of the voting rights or capital of A; or (f) A owns or controls 20% or more of the voting rights or capital of CL. (3) “Subsidiary undertaking” includes all the instances mentioned in Article 1(1) and (2) of the Seventh Company Law Directive in which an entity may be a subsidiary of an undertaking.

Adequate resources 4(1) The resources of the person concerned must, in the opinion of the Authority, be adequate in relation to the regulated activities that he seeks to carry on, or carries on. (2) In reaching that opinion, the Authority may— (a) take into account the person’s membership of a group and any effect which that membership may have; and (b) have regard to—

(i) the provision he makes and, if he is a member of a group, which other members of the group make in respect of liabilities (including contingent and future liabilities); and (ii) the means by which he manages and, if he is a member of a group, which other members of the group manage the incidence of risk in connection with his business.

Suitability 5 The person concerned must satisfy the Authority that he is a fit and proper person having regard to all the circumstances, including(a) his connection with any person; (b) the nature of any regulated activity that he carries on or seeks to carry on; and (c) the need to ensure that his affairs are conducted soundly and prudently.

2.4

Financial Approach

Services

Authority’s

[209] The Observer, 7 October 2001 ‘[Howard] Davies [chair, FSA], at least, is happy with the progress. Others are less certain. The FSA was supposed to replace the box-ticking, legalistic approach that dogged predecessors like the Personal Investment Authority with a more flexible approach based on high-level principles. Many question whether that aim is being achieved. “There can be a tendency for lawyers to get involved in a major way in drafting the legislation so that the commonsense of the policymakers is sometimes obscured

by the legality of the text,” said Peter Beales of the London Investment Banking Association. Davies’ answer is typically robust: “That is what they asked for. We began with a regime that was based more on principles, less on detail. At every point, we were pressed for more detail, more detail. Sometimes industry practitioners will say they want something else but the compliance officers and legal people want total clarity.” Davies believes that the system can still be made to work flexibly: “I think we can square the circle. Also, we will operate the system in a risk-based way — we will focus on the areas of structural risk.”

[210] FSA, “Authorisation” in Handbook of Rules and Guidance (London, FSA, 2003) ‘AUTH 1.4.4 The FSA’s approach to applications for Part IV permission: an overview (1) Alongside the assessment of the threshold conditions… the FSA will operate its risk assessment process. This process enables the FSA to be proportional in its procedures, both in terms of the information which it seeks from an applicant and in the allocation of its own resources. The outcome of this process will help determine the relationship the FSA will seek to have with the applicant if it gives it Part IV permission. (2) The process will include assessing the risks posed by the applicant against a number of probability and impact factors. The probability factors relate to the likelihood of an event happening, and the impact factors indicate the scale and significance of the problem if it occurred….’

Note:

The Handbook contains detailed regulations and guidance on the authorisation and continuing supervision of authorised firms and approved persons (that is, those who undertake ‘controlled functions’, which are defined in the Supervision module of the Handbook at SUP 10.4). On risk assessment, see also, Handbook: Supervision SUP 1.3, and FSA, The Firm Risk Assessment Framework (London, FSA, 2003). [211] Howard Davies (Chair, FSA), “‘Rational Expectations’ — What Should the Market, and Policyholders, Expect from Insurance Regulation?” Airmic Annual Lecture, 29 January 2002 (www.fsa.gov.uk) ‘The biggest decision of principle is just how safe one wishes to make the industry. Let me put the point starkly in relation to the life sector. It would be possible to reduce the risk of failure in the life insurance industry to approaching zero by requiring all life companies to keep their assets in the form of cash and short-dated government obligations. In those circumstances there would be next to no liquidity risk and almost total certainty about future returns. Those returns, however, would be unexciting, limited to the risk-free lending rate, with a reduction for the costs of marketing selling and portfolio management. In real terms, it is unlikely that life insurance companies would be able to show a positive return to investors. So as soon as one moves away from this unexciting, but certainly safe model, one is allowing risk to enter the system. For quite a long period customers have benefited from the fact that life insurance companies have been able to keep a large proportion of their assets in equities. Just at

the moment, that does not look such a brilliant idea, and bonus rates are being cut across the market in response to depressed equity market conditions after two years of market falls, the first such period for 25 years. But allowing the possibility of higher returns inevitably brings in its train the possibility of failure. In the case of general insurance, too, an attempt to eliminate failure could have other damaging consequences. There would possibly be greater industry concentration, reduced product choice, less innovation and higher costs. A dynamic industry cannot be one in which all win prizes. So we have said, from the moment I assumed responsibility as Chairman of FSA, that we are not aiming at a zero failure régime, which would be undesirable in theory and unachievable in practice. It is a depressing, perhaps inevitable feature of my life that while I can secure broad theoretical agreement across the political spectrum for this general proposition, whenever there is an actual company failure, that consensus seems to fade away, and the immediate assumption is that there must have been some inadequacy in the regulatory régime itself, or in the way that régime was administered. I recognise that this comes with the territory. And I would certainly not argue that failures should simply be accepted without any assessment of why they occur. That is why we carried out, promptly and transparently, our own assessment of the circumstances surrounding the closure of Equitable Life to new business. But I hope it is recognised that a corporate failure is not necessarily a failure of regulation. It may simply be a sign that market forces are working. As Gore Vidal once observed, “it is not enough to succeed: others must fail”. We have already said that we would like to move to a régime which is closer to that being developed for banks by the Basel Committee [Basel Committee on Banking Supervision]. In other words one which is more forward

looking and involves firms themselves making their own specific assessment of the overall level of financial resources they need to meet their liabilities, and regular stress and scenario testing. We would envisage setting individual capital requirements for higher risk firms in future, and providing a consistent set of guidance on systems and controls, covering all sectors. All of these changes must be undertaken bearing in mind, as I have said, our principles of good regulation, and also taking into account developments under way in the European Union and the wider world. We have to recognise that UK companies face global competition and that we should not tie their hands behind their back in that contest. But success in the insurance market is certainly heavily related to a reputation for safety and soundness, and for maintaining reliability in paying out claims. So a more robust prudential environment can be a competitive advantage. That is one rational expectation you may have of the regulatory régime. We normally think of the prudential régime as something which sits under our market confidence objective. But it is clear from what I have said about losses over the last 10 years that prudential failure has been an important source of consumer detriment. So a robust prudential régime is part of the consumer protection work of the Authority, too.’

[212] John Tiner (Managing Director, FSA), “The FSA’s Radical New Approach to Insurance Regulation”, Central & Eastern European Regulators Seminar, Wroclaw, Poland, 27 June 2003 (www.fsa.gov.uk) ‘Crucially, the Act [FSMA] sets out four objectives which the FSA is required to work towards and to report publicly each year on its achievements against those objectives…These

objectives are: to maintain market confidence to secure an appropriate degree of protection for consumers, to promote public understanding of the financial system and to reduce financial crime. In making our regulatory judgements about policy decisions, sector wide issues or individual company problems we are required to have regard to what the Act describes as principles of good regulation. These principles cover the need to be efficient in our use of resources, emphasise the importance of the responsibilities of the senior management of firms as the first line of defence in respect of our statutory objectives, require us to consider the implications of our decisions on competition, innovation and the competitiveness of the UK market and the need for our actions to be justified on the grounds that they are proportionate to the risks to the objectives I have just referred to. We have worked very hard to operationalise these objectives and principles of good regulation so that day in day out they are the benchmark against which we consider all of our key decisions, such as where we prioritise resources and the possible actions we may take against individual firms. The FSA is sometimes referred to as an integrated regulator. Many people think of this as a single regulator across the various sectors of the financial markets — banking, insurance, securities, exchanges, advice — and indeed that is true — with one qualification that I shall refer to in a moment — but, importantly, it also represents the integration of prudential supervision and conduct of business regulation. Some commentators suggest that there is an inherent conflict between the market confidence aspects of prudential supervision and the consumer protection aspects of conduct of business regulation. My view on this is that it is true there are times when there is a tension between them, although in a market economy it is by no means inherent in the system and I believe that any such tensions are best resolved within a single regulatory

body than between multiple bodies who can only deal with the tension in a way which damages the very objectives the regulatory systems should be working towards. …Before I go on to talk about this agenda of reform, I think it is important that I mention five key principles that are at the heart of the FSA’s regulatory regime. — The first is that we are risk-based regulators. This means that in respect of consumer and industry-wide issues and for each individual firm, we make an assessment of the risks they present to our four statutory objectives. We then allocate our resources according to that analysis and, therefore, determine the intensity of our regulatory effort at a firm level. We analyse on a quantitative basis, the impact that each firm could have on our ability to meet our statutory objectives and then we do a qualitative assessment of the probability of risks arising, which may threaten that ability. I would note, that our risk-based approach also encompasses enforcement, where we plan to take cases forward which have a significant market impact. — The second key plank to our approach is the “principles of business” that we require all regulated firms to meet. Essentially, these set standards for the way in which we expect firms to operate and include such things as: — A firm must conduct its business with integrity. — A firm must maintain adequate financial resources. — A firm must deal with its regulators in an open and co-operative way. — A firm must treat its customers fairly. — The third principle concerns senior management responsibilities. Here, we look to senior management to satisfy themselves that their firm is operating in a way which meets our requirements. It is not something that can be delegated to a compliance department or, in the case of insurance, to an appointed actuary. It is senior

management and not the regulator who is engaged in their business day in day out and it is right that they should accept the regulatory responsibility which comes with managing their business. — My fourth principle is that the FSA does not aim to operate a zero failure regime. That means that firms will fail and consumers will be mis-sold, but neither can necessarily be regarded as a failure of regulation. We believe strongly that operating a zero failure system would operate contrary to the principle of caveat emptor, would have seriously damaging effects on market competition and innovation and would incur undue and unreasonable cost. — The last point of principle I would like to mention to you is to do with consultation and cost benefit analysis. Under the Financial Services and Markets Act the FSA has rule making powers, but only following a process of comprehensive public consultation. In most cases, therefore, we consult on our ideas for new policy initiatives to address a particular concern, issue a public feedback statement on that consultation and then consult once again on the draft rules to be included in our rulebook. This can slow down the process of improving the regulatory framework and places an onerous burden on firms, their trade associations and consumer representatives in reading and commenting on the consultation documents. But I am quite sure that this kind of transparency in policy-making is an essential element in building confidence in the regulatory system and in minimising unintended consequences of such decisions… Moving on then to the question of insurance. I think it is fair to say that the role of insurance companies within our economies, and indeed in the global economy is becoming increasingly noticeable, if not increasingly important. We are

all aware of the demographic challenges facing Governments around the world and the implications for the funding of an ageing population. Falling equity markets and lower long-term interest rates have further underlined how important a well capitalised and thriving life insurance sector is to the long term savings of hundreds of millions of people. The general insurance industry continues to be an essential mechanism in the transfer of risk from individuals, corporations and governments who do not have the knowledge, appetite or finances to take certain risks, to institutions that do. So, claims as diverse as the victims of the severe floods in the Eastern parts of Germany in 2002, to workplace diseases which may have incubation periods of several decades, to claims emerging from the terrorist attack on 11 September have all tested the resilience of the general insurance industry. Similarly, the re-insurance industry, which is unregulated in many countries, has come to the fore in the light of its crucial role in supporting catastrophe risk and in maintaining financial stability. It is probably true to say that, in the past, insurance regulation has been more focussed at the national level than, say, banking, although the work of the International Association of Insurance Supervisors has recently been more pro-active in working up standards on solvency, reinsurance and financial instruments such as securitisation and credit derivatives. We very much support this stronger co-ordination at an international level and, within the European Union the establishment of the Committee of European Insurance and Occupational Pension Supervisors (CEIOPS)… The insurance market in the UK comprises some 600 life and general insurers plus 200 small mutuals that we call Friendly Societies. Of course the UK also hosts the Lloyd’s of London Insurance Market, which has an underwriting capacity of some £15 billion.

When the FSA took over banking supervision from the Bank of England and insurance regulation from the Department of Trade and Industry, we took over two very different kinds of business. One very simple point is that the resourcing levels were very different indeed. We inherited almost 400 people for nearly 600 banks and just 70 people for over 800 insurance companies. There were some reasons to explain this remarkable difference. The insurance supervisors’ efforts were supplemented by the work of around 20 actuaries in the Government Actuaries Department, who have since also moved to the FSA. But the differences the staffing numbers, and the intensity of work, were nonetheless very striking. To simplify somewhat, the relationship between insurers and their supervisors was less close than was the case with banks. Insurance supervisors rarely visited the firms they oversaw. They typically did not know the senior management well, if at all. And the relationship was based more on lengthy statistical returns, analysed by actuaries, than on an understanding of business strategy and risk management, which is the foundation stone of banking supervision, at least its practice in the UK post BCCI and Barings [two banking failures in the early 1990s] era. The problems of Equitable Life and the lessons for the regulators are identified in a public report by the FSA’s internal auditor, Ronnie Baird. This report highlighted a number of deficiencies with the system of insurance regulation that we inherited. Under the auspices of the Tiner Project we have looked under the stone of almost every aspect of how we regulate insurance companies and our proposals for change are set out in our report on the future regulation of insurance of October 2002 and the several consultation papers we have published both before and after that report. Today, I would like to touch on three of these:

— risk assessments of insurers; — governance in life insurance companies, including the role of actuaries; — and risk-based capital for insurers. We have now completed risk assessments of the largest 200 life and general insurance companies. These risk assessments are conducted by both on-site visits to firms, including interviews with all levels of management, and desk-based analysis of information, both quantitative and qualitative, that we have gathered from firms and other sources. Our risk assessment focuses on both business risks and control risks. On business risks, we want to understand firms’ strategies and their process for developing and approving strategy. We will want to assess how they manage their underwriting risk, including pricing, excesses, terms and conditions and exclusions and how they manage their net underwriting risk through the re-insurance market. We will also want to understand how they identify and manage investment and credit risk. So for example what are their investment strategies about asset mix, duration, concentration and what risk parameters do they set for credit exposures for example on their bond portfolio and, importantly, in respect of their re-insurance protection. In the area of control risks, we look at the governance arrangements of the company — the decision-making structure, independent oversight and, ultimately, how the Board exercises its responsibilities for the proper management of the institution. We then assess the firms’ systems and controls and management of operational risk, such as legal risk, systems failure risk and so on. Once we have completed this risk assessment we write to the governing body of the company, usually the Board of Directors, setting out our assessment and the areas where we think the firm or the FSA needs to take further actions to mitigate the extent of the risks identified. These actions

may include firms agreeing to tighten procedures, say over the management of their outsourcing arrangements with third parties who process claims, or the FSA asking a firm of accountants to review the underwriting process where we may have concluded that controls may not be adequate and that a more detailed diagnostic assessment with recommendations for improvements needed to be made. Consistent with our focus on senior management responsibilities, we look to the Board to respond to us on all the points we make. Generally speaking, we have found this risk assessment process to be an effective way of understanding the extent to which individual firms may pose risks to market confidence, consumer protection or financial crime and that it provides a forum for an effective two-way dialogue with the firm and, for the 20 largest insurance firms, what we call a close and continuous relationship. …[Another] area of perhaps the most significant reform is in the field of solvency or what we might in the future refer to as risk-based capital. The drivers for change here are international accounting standards, the Solvency 1 and Solvency 2 EU Directives and the new Basel Accord for banks. Work on international accounting standards for insurance contracts and for financial instruments more generally, including progress towards fair value accounting will have a profound effect, especially for life insurance firms. The main effect is likely to be a shift away from creating reserves through a conservative valuation of liabilities, and away from the use of limits on the admissibility of assets as a means of making up for deficiencies in valuation. This will then require greater emphasis on capital to meet unexpected claims or losses and this in turn should create: greater clarity in assessing the true financial condition of an insurer; greater convergence between the accounting and regulatory treatments of balance sheet items, closing the gap between

accounting and economic reality; and greater cross-sector harmonisation and international convergence. …You might be surprised to hear me include a proposed international banking standard in the list of key international drivers towards modernising insurance regulation. But we do think that the framework provided by the Basle accord, consisting of three mutually reinforcing pillars — minimum capital requirements: supervisory review of a firms own internal capital assessment: and market discipline is one which has clear application in the insurance sector. That is not to say, I should emphasise, that we think the prudential system for banking should simply be transported across to insurance. Insurance is a different business to banking and we need a fit for purpose risk sensitive system of prudential regulation consistent with the three-pillar framework. In the life insurance sector, we have observed during the recent equity market volatility that the way in which the statutory basis of solvency works in falling equity markets can force perverse decisions on asset allocation. Indeed, given the relatively inelastic relationship between asset prices and mathematical reserves, and the materiality of life insurers as investors in the equity market, that the current rules can push the market to overshoot at both the top end and the bottom end of a cycle. We, therefore, plan to introduce a new approach to measuring the solvency of life insurers based on “realistic” assessment of assets and liabilities together with a “safety margin” or “capital buffer” to cover adverse market developments. The key factors in the realistic approach are: — Stating liabilities at the amount a firm expects to have to pay, discounted to a present value. Importantly, for with-profits business, this means quantifying both guaranteed and discretionary benefits, the latter being more sensitive to movements in asset values, including equity prices.

— Using capital markets techniques to quantify the value of options and guarantees that maybe embedded in policyholder contracts. This would mean taking into account the time value, intrinsic value and volatility relevant to the policyholders contractual rights. Firms are developing their valuation and risk management techniques in this area and the more advanced firms are now able to assess and value these commitments on the basis of stochastic models. Life insurance firms must also be able to demonstrate that it has sufficient financial resources to meet its realistic liabilities under stressed circumstances, as well as under normal conditions. This is why a safety margin is needed in excess of normal realistic liabilities. We expect to require firms to assess a range of factors including key market risks such as equity values, property values and movements in the yield curve, as well as credit risk shocks in the asset portfolio. …I have referred previously to the controls we expect firms to have in place in managing credit risk and our proposal to include a credit risk shock in the assessment of the capital buffer. Recently, we have conducted the first ever detailed study on some key aspects of credit risks among UK life insurers and, if I may, I would look to take a minute or two to summarise the results of the study. Credit risk is one of the many risks run by life insurance firms. It is the risk that a counterparty that owes them money will not pay the full amount promptly when it falls due. This risk exposure does not come from their direct customers; they pay premiums in advance to insure their benefits. Credit risk comes mainly from the investment operations of insurers, for example in investing reserves in bonds and other assets to build up a fund to meet future claims, or through hedging via derivative contracts. Credit

risk exposure also arises through the placing of reinsurance contracts and cash management operations. The nature of UK Life Insurers credit risk exposures has changed significantly over the last few years as they have switched out of equities during the bear market, mainly into bonds. From information gathered by FSA we estimate that life insurance firms sold about £30 billion of equities from their with-profits funds during 2002. We anticipate that most of this was reinvested in bonds. Detailed information on credit risk exposures from holdings of bonds and similar securities has not been routinely gathered through the annual returns so a survey of firms with large exposures in corporate bonds has recently been conducted. The survey covered about 50 of the larger life insurers in UK with bond portfolios in excess of £120 billion in total. The results of this survey indicate that the industry in the UK has generally adopted investment policies that set appropriate limits for credit risk appetite and for exposures to individual counterparties. The investment portfolios generally comprise good quality credit risks consistent with the stated investment policies, and the reserves set up for credit risk are, on average, what we would expect, given the loss experience that they have suffered. The survey was conducted by sending questionnaires to the larger life insurers in the UK and analysing the data contained in the completed questionnaires. Information was requested on investment policies with specific focus on the appetite for credit risk, exposures to individual counterparties, and exposures to market sectors. Clearly defined limits were set by most companies for the maximum exposure to credit risk, and about half also set a target level for the credit exposure that they wanted to take on, within the maximum set. Clear limits were also set for exposure to any one counterparty, although only in the investment portfolio. Some firms had defined rules for exposures to

market sectors, though most firms said only that they maintained well-diversified portfolios. …Information was also gathered on reserving. This is a very technical area. Assets are brought in to the balance sheet at market value, a valuation basis that should make appropriate provision for all risks, including credit risk. Firms must make a deduction for risk from the redemption yield on the asset in setting the basis for calculating technical provisions for statutory purposes. The bases described for making these deductions would produce, on average, deductions at a reasonably prudent level. Some firms also had procedures for limiting the risk-adjusted yields on bonds where these would otherwise be unusually high. On the non-life side we will be publishing a consultation paper in the next week or two on a risk-based enhanced regulatory capital requirement. We intend to decompose risk into three main components: insurance risk, counter party risk and market risk. Within these, different capital charges will be applied to different types or classes of business to reflect the different risk in each case. So, for example, within insurance risk, household, motor and travel insurance might be subject to a lower risk weighting than long term liability insurance. Similarly, asset risk charges will aim to capture, at least to some extent, counter-party risk and market risk — including interest rate risk — by applying different risk weightings to different types of assets. We are not, as I have said earlier, aiming for a zero failure regime but we do want the minimum requirement to reflect a reasonably high level of confidence that an insurer will remain solvent even if subject to a plausible range of adverse shocks. We also think our proposed approach introduces much greater risk sensitivity into the requirement, aligns regulatory capital more closely to economic capital and allows for a more transparent measure of capital adequacy. At this stage, we are simply consulting on an approach to the calculation of enhanced regulatory

capital and we will work closely with the industry to determine whether our proposed calibrations are appropriate, what impact the new tests have on the level of insurance company capital and when the new tests should be introduced and in what form. Looking forward, we will afford insurers the opportunity to use internal models and stress and scenario tests to determine their own level of capital required to support their business. We will take into account this internal capital assessment in considering whether we should grant waivers to allow firms to operate at a level of capital lower than that determined by our rules. All of this presents both the regulator and the industry with significant challenges. There is an urgent need to deepen and broaden the pool of resources within the insurance industry who are able to lead the development and implementation of these new concepts.’

Note: For the Tiner Report, see Financial Services Authority, The Future Regulation of Insurance: A Progress Report (‘The Tiner Report’) (London, FSA, 2002). [213] Howard Davies (chair, FSA), “A New Approach to Insurance Regulation”, The Geneva Association 30th General Assembly, London, 12 June 2003 (www.fsa.gov) ‘To simplify somewhat, the relationship between insurers and their supervisors were less close than was the case with banks. Supervisors very rarely visited the firms they oversaw. They typically did not know the senior

management well, if at all. And the relationship was based more on lengthy statistical returns, analysed by actuaries, than on an understanding of business strategy and risk management, which is the foundation stone of banking supervision, at least as practised in the UK post BCCI and Barings. To simplify, once again, our approach at the FSA is to work towards some degree of convergence between these two dramatically different styles of supervision. Over the last five years we have, in net terms, reduced the resources devoted to banking supervision, and banks have paid lower fees to us, as a result. By contrast, we have increased the numbers of insurance supervisors quite considerably…Also, we have broken down the barriers between the two groups. We now supervise the largest companies, whatever their principal line of business, on a group basis, so the major British insurance groups are now handled by our Major Financial Groups Division, rather than by our Insurance Division. …I think it is fair to say that, in different ways and different places, other integrated regulators around the world are moving in a similar way, though perhaps none — so far — have gone quite as far as we have in integrating different disciplines. Why have we done this? Is a reasonable question to ask. What was wrong with the old approach? Had it not served the industry well over a number of years? It may be that the old approach was appropriate at the time it was devised. Though I note that there have been a surprising number of general insurance failures over the years. I do not subscribe to the view that regulators should seek to prevent all failures — far from it. We have explicitly said that we do not plan to oversee a zero failure regime. But in the last five years, the Financial Services Compensation Scheme has paid £312mn to policyholders,

and is dealing with claims arising from the failure of 25 general insurers, and one small life assurer. More importantly, the role insurance companies play in the financial system, and the impact of their activities on financial stability, has changed significantly. In the first place, insurers have been moving into other types of business, notably into banking itself. Insurers have been large players in the derivatives market, particularly taking on sizeable volumes of credit risk from the banking sector through credit derivatives… And on the life insurance side, highly volatile and bearish equity markets have revealed unexpected vulnerabilities, and have starkly demonstrated that elements of the prudential regime we inherited could in certain circumstances add additional downward pressure to markets, and create perverse incentives. This is true elsewhere, too. Indeed some other countries have additional problems — such as legislated guaranteed rates of return — which have put additional pressure on their companies’ solvency. These general trends, and the specific difficulties of Equitable Life and Independent Insurance, have caused us to undertake an extensive rethink of our approach to insurance supervision in the UK. There is not time today for a comprehensive review of those changes. And, in any event, we have set out the details in a number of published papers. So let me confine myself to two general points, which I hope will be of interest to others here who are not subject to the tender care of the FSA. I will talk briefly about the character of the relationship we want to have with insurers, and then say something about the broad lines of the changes to the prudential regime which we envisage. …When we moved to full integration of the different regulatory bodies which came together in the FSA, we decided that we needed a single risk model to determine

our allocation of resources. We have now developed such a model, whose architecture is built around our four statutory objectives: maintaining confidence in the financial system, protecting consumers, promoting public understanding of the financial system and fighting financial crime. Using that model we have classified all 12,000 firms we oversee according to the risks they pose to those objectives. And we have then put them into categories, which are used to determine the amount of effort we think it appropriate to put in. Though the procedure is somewhat complex the outcome is straightforward. There are A firms, B firms, C firms and — wait for it — D firms. D firms are small, and we generally supervise them on a remote basis, monitoring their financial returns, but not visiting them in a systematic way. Many of the friendly societies — small mutual insurers — are in this category. At the other extreme there are A firms, with which we think we need a close, continuous, and upfront and personal relationship. It sounds fun — and sometimes it even is. The net result of this categorisation, which is only just complete, is that we have 70 firms in the A box, and of them 22 are insurers. Wild horses would not drag the names of these firms out of me… I think it is fair to say that, initially, there was some nervousness in the lodges and covens in which insurers meet, about the consequences of this new approach. But I hope it is also now true to say that both sides see the advantage of a closer relationship. In a volatile and risky market environment, in particular, it is crucial for the regulators and the regulated to understand each other well. And within that relationship we think it important for us to reach a view on the quality of management, and also on the quality of risk management and control systems. Furthermore, we think it important that firms themselves know how we see them, and how they compare with best of breed in each case. So the risk assessment is sent to the full

Board, and our supervisors now often make a presentation to the Board. That follows a practice we introduced in banking supervision in the late 1990s. We think Boards should know how the regulators see them.’

Note: In another speech Howard Davies said, ‘When the Authority was established there was some concern about the way in which it would interact with the Bank of England, which retains responsibility for the stability of the financial system as a whole. Those concerns have proved groundless. That is partly attributable to the structured relationship established under the Tripartite Standing Committee, which allows the Treasury, the Bank and the FSA to monitor trends in financial markets, and potential threats to their stability.’ (“Speech to FSA Annual Meeting, London”, 17 July 2003 (www.fsa.gov.uk))

2.5 Lloyd’s Insurance Market The Society of Lloyd’s is not an insurer, but provides the environment — both physical, in terms of buildings, and legal, in terms of bye-laws by which business is regulated and members controlled — within which the Lloyd’s insurance market operates. Under legislation in 1871 its bye-laws acquired legislative status. An act of 1911 set up a guarantee fund to ensure that all liabilities under policies taken out at Lloyd’s would be met. The principal legislation

is the Lloyd’s Act 1982, which established a new constitutional structure. Under this Lloyd’s is governed by a Council, whose working members form the Committee of Lloyd’s. In practice, the Committee undertakes the key roles of making bye-laws and issuing codes of practice relating to the market. Disciplinary functions are in the hands of the Disciplinary Committee and the Appeal Tribunal, both of which were also constituted under the 1982 Act. Since the 1970s Lloyd’s has been beset with a serious of problems, which came to a head in the 1980s. There were a number of catastrophes involved risks underwritten at Lloyd’s, such as the Exxon Valdez disaster and the massive claims in the USA for injuries related to asbestos. In addition, the market’s internal organisation threw up some problems: the London Market Excess of Loss Spiral, under which risks were underwritten and then reinsured within a small number of Lloyd’s syndicates, placed pressure on the Members who constituted those syndicates and who provided their financial backing; and large calls on Members, whose liability was unlimited, forced many into bankruptcy. There were a series of actions alleging negligence in the underwriting practices employed in the market. During the 1990s major reforms were introduced to reorganise the market, deal with past liabilities and settle litigation brought by Members. For discussion of the law on the formation of insurance contracts at Lloyd’s, see chapter 5, Part 5.6.

[214] FSA and Society of Lloyd’s, Supervision Arrangements for Underwriting Agents: Enforcement Co-operation Arrangements (London, FSA, 2003) (www.fsa.gov) ‘Under Lloyd’s Act 1982 the Council of Lloyd’s has power to regulate and direct the business of insurance at Lloyd’s. The 1997 Regulatory Review Group stated that the objective of Lloyd’s regulation was to provide reasonable safeguards for Lloyd’s policyholders, members and component businesses in order to establish a basis for confidence that Lloyd’s is a solvent and soundly managed market in which to do business. To that end, Lloyd’s regulation seeks to set and enforce standards designed to ensure that: — the market and those trading in it are solvent; — those doing business in the market are competent and honest; — all market users are fairly and impartially treated; — the market is as transparent as possible; and — the market is not misled, manipulated or abused.’

Since the FSMA, although the FSA is responsible for ensuring compliance, much of the work of supervision has been left to the Society of Lloyd’s, (see, FSA, Lloyd’s Sourcebook (London, FSA, 2001); FSA and Society of Lloyd’s, Supervision Arrangements for Underwriting Agents: Enforcement Co-operation Arrangements (London, FSA, 2003) (www.fsa.gov). Nevertheless, the FSA retains the power to subject Lloyd’s to direct regulation.

2.6 International Harmonisation

Competition, innovation and technology have meant that insurers are increasingly looking outside their domestic markets and their traditional lines of business. Multifunctionalism (insurers engaging in non-insurance financial business, such as banking), multinationalism (insurers operating in different countries through branches, subsidiaries and crossborder selling) and globalisation (the interconnectedness of financial markets across the world) has posed problems for regulators. The first is that insurers may be entering markets and businesses with which they are unfamiliar and this may expose them to additional risks. In addition, regulators are confined by territorial boundaries, and, in many countries, they are tasked to deal with just one aspect of the financial services industry. These issues were first confronted in the banking sector by the Basel Committee on Banking Supervision, which was set up by the G10 countries in 1974 when the collapse of Bankhaus Herstatt exposed the problems of supervising international banks. The Basel Committee has no legal powers, but its proposals have acquired a powerful weight among supervisors. The Committee developed the idea that the supervisor in the state in which a bank is authorised (the home state) should undertake supervise the bank’s entire operation (consolidated supervision). This rested a good deal of responsibility on supervisors and the concern was that if home supervision was not adequate that might affect other countries in which the bank operated. The Committee, therefore, proposed that host states

should assess the competence of a bank’s home supervisor and, if dissatisfied, they could restrict the operations of the bank. This also sought to address the problem of the so-called ‘race to the bottom’ whereby states sought to attract banks by offering a low level of regulation. Basel also emphasised the importance of information exchange between supervisors. Another facet of the Committee’s work has been to set minimum standards in the area of capital adequacy and encourage countries to adopt these as a means of facilitating the supervision of international financial firms. The Basel Committee prompted the establishment of the International Association of Insurance Supervisors (the IAIS). This was set up in 1994, but, while Basel has a limited membership, the IAIS draws its members from around one hundred jurisdictions and welcomes about 60 observers from the industry and professional associations to its meetings. The Basel Committee, the IAIS and the International Organisation of Securities Commissions have established the Joint Forum for dealing with issues of mutual concern, including the issue of multinational firms (the papers of the Joint Forum are available at www.iaisweb.org; see also papers from the Executive Seminar on Insurance Regulation and Supervison held under the auspices of the Organisation for Economic Co-operation and Development, Tokyo, 1999, www.oecd.org). Following the example of the Basel Committee, the IAIS has created 28 core principles, which are intended to provide benchmarks for an effective

supervisory system and for assessing the effectiveness of an existing system (Insurance Core Principles and Methodology, October 2003, www.iaisweb.org). These core principles are supplemented by further principles, supervisory standards, guidance notes and discussion papers: so, for instance, the IALS has issued sets of principles on the minimum supervisory requirements for reinsurers (2003), on capital adequacy and solvency (2002), on the supervision of insurance provision through the internet (2000) and on the supervision of international insurers and insurance groups and their cross-border operations (1997, amended 1999). The expectation is that member national supervisors will meet these standards, and they are also used by the International Monetary Fund in conducting its Financial System Stability Assessments of individual countries (see [206]). [215] C Mayer, ‘Regulatory Principles and the Financial Services and Markets Act 2000’ in E Ferran and C Goodhart, eds, Regulating Financial Services and Markets in the Twenty First Century (Oxford, Hart, 2001) ‘If institutions are mobile between markets then they will seek the regulatory and tax regimes that impose lowest burdens. If investors are mobile between markets then they will select the regimes that provide their preferred combination of investor protection and cost of investment. They will not necessarily select lowest cost regimes any

more than they automatically choose highest risk investments. Where there are systemic risks then there are spillovers from one institution and market to another. Individual regulatory agencies will not take adequate account of the international repercussions of failures in their domestic markets. The protection of financial and monetary systems therefore requires international harmonisation of regulations. In the absence of such harmonisation, competition creates a run to the bottom. However, where systemic risks are not present, regulation need not and should not be harmonised. Competition between institutions and between financial centres in selecting different standards encourages product variety and efficiency in the delivery of financial services.’

Note: Although Mayer’s essay is concerned primarily with issues relating to banking where the effect that a wholesale collapse (that is, systemic risk) would have on a national economy is greater than a collapse among insurers, similar considerations can be applied to the discussion of insurance, particularly in view of the spread of multifunctional financial firms. [216] Clive Briault (Director, Prudential Standards, FSA), “New Prudential Regime for Insurers”, City & Financial Conference on the FSA’s Proposed Capital Adequacy and Reporting Standards for Insurance Companies’, London, 17 October 2002 (www.fsa.gov.uk)

‘[One of the drivers] for change in prudential insurance regulation is international developments. Three of these are of particular importance. Work on international accounting standards for insurance contracts, and for financial instruments more generally, including progress towards fair value accounting, will have a profound effect, especially for life insurance firms. The main effect is likely to be a shift away from creating reserves through a conservative valuation of liabilities, and away from the use of admissibility limits on assets as a means of making up for deficiencies in valuation. This will then require greater emphasis on capital to meet unexpected claims or losses. And this in turn should create: — Greater clarity in assessing the true financial condition of an insurer; — Greater convergence between the accounting and regulatory treatments of balance sheet items, closing the gap between accounting and economic reality; and — Greater cross-sector harmonisation and international convergence. Next, progress in the EU towards the Solvency 2 Directive. The current minimum EU standards are certainly out of date and seriously flawed. As is generally accepted by the nonlife industry, the current required margin of solvency is set too low. It therefore provides an inadequate buffer to absorb unexpected losses. Even for a low-risk non-life insurer, past experience has demonstrated that there are plausible loss scenarios in which the capital cost would be a multiple of two or more times the current required solvency margin. Most non-life firms therefore choose voluntarily to hold well in excess of this required minimum. Moreover, the current EU minimum solvency margin for non-life insurers is calculated by reference to volume, not

risk, measures. We even have the perverse outcome that a decline in premium income will generate a lower solvency requirement, just at the time when the profitability of an insurer may be under strain. This absence of risk-sensitivity also means that the current standard provides no incentive for non-life insurers to exercise good risk management. And it provides no basis on which either firms or their regulators can track actual capital relative to the capital required by the risks that the insurer is facing. As yet, Solvency 2 remains on the drawing board and is unlikely to be implemented until 2007 at the earliest. But we hope — and are actively engaged in trying to ensure — that the new Solvency 2 Directive will be a major step in the direction of a genuinely risk-sensitive and properly calibrated approach to solvency requirements for both life and non-life insurers. We would also like to see a much greater role for scenario and stress tests in the prudential framework. But at this stage it is impossible to be certain about what the Solvency 2 Directive will contain. The final strand of the key international developments is the proposed new Basel Accord for internationally active banks. Some of you might be surprised to hear me include a proposed international banking standard in the list of key international drivers towards modernising the insurance regime. But this shows how significantly things have changed in recent years. The proposed new Basel Accord consists of three mutually reinforcing pillars — minimum capital requirements; supervisory review of a firm’s own internal capital assessment; and market discipline. It recognises, in particular, that ultimate responsibility for managing risk and ensuring that capital is held at a level consistent with a bank’s risk portfolio rests with the bank’s management. The Accord reflects the view that regulation needs to move beyond exclusive reliance on the external imposition of formula-based capital requirements.

Pillar one of the Accord updates the capital formula but also encourages the alternative use of internal modelling for credit and operational risks, in addition to the market risk models that banks can already use if they meet the challenging entry criteria. Pillar two requires banks to have adequate processes for assessing their overall capital adequacy in relation to their risk portfolio and a strategy for maintaining their capital levels. Supervisors are tasked with reviewing and evaluating banks’ internal capital adequacy assessments and strategies. One key purpose of Pillar two is to ensure that firms hold adequate capital against risks that are not captured — or are captured inadequately — under Pillar one. Pillar three recommends minimum levels of public disclosure of capital, risk exposures and capital adequacy. We believe that this three-pillar framework is no less relevant to the prudential regulation of insurance firms. While many of the details of the Accord cannot transfer directly to the insurance sector, the underlying philosophy has informed our own proposals for the reform of the insurance prudential regime.’

[217] International Association of Insurance Supervisors: Bye-laws, 1999 (www.iais.web.org) ‘1. Preamble THE INSURANCE SUPERVISORS referred to in PART 2 of these bye-laws RECOGNIZE that the insurance industries and markets are of fundamental economic and social importance, nationally and internationally; RECOGNIZE that most domestic insurance markets are increasingly being integrated into a global market; WISH TO

— formally establish an independent forum for meetings of insurance supervisors for their mutual benefit; — engender awareness of common interests and concerns among such insurance supervisors; — encourage wide international personal and official contacts among insurance supervisors; — enhance the ability of insurance supervisors to better protect insurance policyholders and to better promote and secure efficient insurance markets. RESOLVE — to co-operate together to ensure improved supervision of the insurance industry on the domestic as well as on an international level in order to maintain efficient, fair, safe and stable insurance markets for the benefit and protection of policyholders; — to unite their efforts to develop practical standards for supervision of insurance that members may choose to apply; to liase or co-operate with other relevant international entities; to provide mutual assistance to safeguard the integrity of markets; — to exchange information on their respective experiences in order to promote the development of domestic insurance markets.’

2.7 European Harmonisation A key feature of the European Union is the creation of a single market in goods and services. In the context of the financial services industry, the idea is to provide a common framework that allows insurers, which are established within a member state, to operate freely throughout the EU, either by setting up branches in other countries or by selling across

borders, without having to seek authorisation in each country. The first problem was to decide which country should regulate a firm: where, for example, a French insurer sets up an insurance business in the United Kingdom, should regulation be undertaken by France as the home state or the UK as the host? In line with the approach taken by the Basel Committee on Banking Supervision, the choice has fallen on the home state, that is the country where the insurer is authorised, subject to limited powers given to the host to restrict entry. This required measures to ensure that each member state operated a regulatory regime with which the other member states were content. The approach has been to introduce a measure of harmonisation so that all member states authorise and supervise insurers according to the same minimum standards. The reforms have been achieved in three stages: the first generation of directives required member states to allow insurers to become established without discrimination on grounds of nationality, but retained host state control; the second generation entitled an insurer established in one member state to engage in insurance business in another member state without further authorisation requirements; the third generation merged the first two by removing the right of the host to insist on an insurer obtaining authorisation if it was already authorised in another member state. Significantly for the UK, which has always countenanced insurers engaging in both nonlife and life business, the EU regime requires a strict separation between these types of business. No new

companies may offer both types and existing companies are required to maintain a strict separation between them. See FSA, Interim Prudential Sourcebook: Insurers (London, FSA, 2002), chapter 3; A McGee, The Single Market in Insurance: Breaking Down the Barriers (Dartmouth, Ashgate, 1998); R Merkin and A Rodger, EC Insurance Law (London, Longman, 1998); R Merkin, ed, Colinvaux & Merkin’s Insurance Contract Law (London, Sweet & Maxwell, 2002). Concern that the single market project was not progressing rapidly enough led to the establishment of the Financial Services Action Plan (Commission, Financial Services: Implementing the Framework for Financial Markets: Action Plan, COM (1999) 232). A recent Commission document on the internal market acknowledged, ‘Considerable differences in regulation from one Member State to the next — and the lack of confidence in each others regulatory systems — are the main reason why free movement of services has so far been more a legal concept than a practical reality. Because of the complex and intangible nature of many services — and the importance of the know-how and qualifications of the service provider — they are generally subject to more wide-ranging and complex legal rules than goods.’ (EC Commission, Communication from the Commission to the Council, the European Parliament, the European Economic and Social Committee and the Committee of the Regions, COM (2003) 238 final)

The paper does, however, go on to assert that the Action Plan has meant that, at least in the area of financial services, good progress is being achieved. Nevertheless, in the enthusiasm for the single market it is important not to lose sight of the consumer; indeed, the Action Plan has flagged this as a key issue. The EU has also sought to deal with multifunctional firms or financial conglomerates, which pose problems for a system that is based on an assumption of separation between these markets: so, for instance, there are separate directives on insurance and on credit institutions (banks and similar firms). The EU directive on supplementary supervision (see [214]) seeks to tackle this issue, but problems remain both in maintaining proper lines of communication where a regulatory system has separate supervisors for different sectors and in dealing with a firm whose activities spread outside the EU. Finally, the EU has eschewed the idea of harmonising insurance contract law: for instance, in Council Directive 92/49/EEC of 18 June 1992, which is one of the third generation of insurance directives, it is declared: ‘(18) Whereas the harmonisation of insurance contract law is not a prior condition for the achievement of the internal market in insurance; whereas, therefore, the opportunity afforded to the Member States of imposing the application of their law to insurance contracts covering risks situated within their territories is likely to provide adequate safeguards for policyholders who require special protection;’

[218] Directive on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate (2002/87/EC) ‘Whereas: (1) The current Community legislation provides for a comprehensive set of rules on the prudential supervision of credit institutions, insurance undertakings and investment firms on a stand alone basis and credit institutions, insurance undertakings and investment firms which are part of respectively a banking/investment firm group or an insurance group, ie groups with homogeneous financial activities. (2) New developments in financial markets have led to the creation of financial groups which provide services and products in different sectors of the financial markets, called financial conglomerates. Until now, there has been no form of prudential supervision on a group-wide basis of credit institutions, insurance undertakings and investment firms which are part of such a conglomerate, in particular as regards the solvency position and risk concentration at the level of the conglomerate, the intra-group transactions, the internal risk management processes at conglomerate level, and the fit and proper character of the management. Some of these conglomerates are among the biggest financial groups which are active in the financial markets and provide services on a global basis. If such conglomerates, and in particular credit institutions, insurance undertakings and investment firms which are part of such a conglomerate, were to face financial difficulties, these could seriously destabilise the financial system and affect individual depositors, insurance policy-holders and investors.

(3) The Commission Action Plan for Financial Services identifies a series of actions which are needed to complete the Single Market in Financial Services, and announces the development of supplementary prudential legislation for financial conglomerates which will address loopholes in the present sectoral legislation and additional prudential risks to ensure sound supervisory arrangements with regard to financial groups with cross-sectoral financial activities. Such an ambitious objective can only be attained in stages. The establishment of the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate is one such stage. (4) Other international forums have also identified the need for the development of appropriate supervisory concepts with regard to financial conglomerates. (5) In order to be effective, the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate should be applied to all such conglomerates, the cross-sectoral financial activities of which are significant, which is the case when certain thresholds are reached, no matter how they are structured. Supplementary supervision should cover all financial activities identified by the sectoral financial legislation and all entities principally engaged in such activities should be included in the scope of the supplementary supervision, including asset management companies. (6) Decisions not to include a particular entity in the scope of supplementary supervision should be taken, bearing in mind inter alia whether or not such entity is included in the group-wide supervision under sectoral rules. (7) The competent authorities should be able to assess at a group-wide level the financial situation of credit institutions, insurance undertakings and investment

firms which are part of a financial conglomerate, in particular as regards solvency (including the elimination of multiple gearing of own funds instruments), risk concentration and intra-group transactions. (8) Financial conglomerates are often managed on a business-line basis which does not fully coincide with the conglomerate’s legal structures. In order to take account of this trend, the requirements for management should be further extended, in particular as regards the management of the mixed financial holding company. (9) All financial conglomerates subject to supplementary supervision should have a coordinator appointed from among the competent authorities involved. (10) The tasks of the coordinator should not affect the tasks and responsibilities of the competent authorities as provided for by the sectoral rules. (11) The competent authorities involved, and especially the coordinator, should have the means of obtaining from the entities within a financial conglomerate, or from other competent authorities, the information necessary for the performance of their supplementary supervision. (12) There is a pressing need for increased collaboration between authorities responsible for the supervision of credit institutions, insurance undertakings and investment firms, including the development of ad hoc cooperation arrangements between the authorities involved in the supervision of entities belonging to the same financial conglomerate. (13) Credit institutions, insurance undertakings and investment firms which have their head office in the Community can be part of a financial conglomerate, the head of which is outside the Community. These regulated entities should also be subject to equivalent and appropriate supplementary supervisory arrangements which achieve objectives and results similar to those pursued by the provisions of this

Directive. To this end, transparency of rules and exchange of information with third-country authorities on all relevant circumstances are of great importance. (14) Equivalent and appropriate supplementary supervisory arrangements can only be assumed to exist if the thirdcountry supervisory authorities have agreed to cooperate with the competent authorities concerned on the means and objectives of exercising supplementary supervision of the regulated entities of a financial conglomerate.’

3 Insurance Intermediaries Insurance products are sold through intermediaries often termed agents or brokers. Even where an insured purchases insurance from an insurance company directly, as is frequently done nowadays via the internet or telephone, issues of agency still arise because the company as a metaphysical entity has to conclude business through the medium of its human agents. The circumstances surrounding the conclusion of the insurance contract will become critical should the parties become involved in a dispute and, as will be seen, an intermediary’s authority to bind his or her principal together with the duties owed to the principal will be central questions. This chapter is divided into five parts: (3.1) types of insurance intermediary and the regulatory regimes; (3.2) the authority of intermediaries; (3.3) identifying an intermediary’s principal and the imputation of knowledge; (3.4) the duties owed by an intermediary to the principal; and (3.5) reform.

3.1 Types of Intermediary and Regulation

Perhaps surprisingly given the well-documented scope for abuse by commission hungry insurance agents, it was not until relatively recently that those who sell insurance products were subjected to any form of systematic regulation. Following a Consumer Council’s report in 1970, the Insurance Brokers (Registration) Act 1977 introduced for the first time a system of formal registration and conferred upon the profession the power to regulate itself. This was followed by the Financial Services Act 1986 which, in accordance with the ideals of the government of the day, sought to reinforce the notion of self-regulation across the financial services industry. The 1986 Act was restricted to long term insurance contracts (ie investment contracts). General insurance was regulated by the Insurance Companies Act 1982. But to complicate matters the 1982 Act also applied to long term insurance as well and so there were a complex set of provisions aimed at preventing overlap between the two statutes. Shortly after the present Labour Government came to power in 1997 the Treasury announced a root and branch reform programme for the regulation of the financial services industry. The backdrop to this initiative was the scandal surrounding the mis-selling of insurance that surfaced in the late 1980s particularly in relation to pensions products and endowment policies linked to mortgages. This reform process culminated in the Financial Services and Markets Act 2000 (hereafter, FSMA 2000) which repealed the Financial Services Act 1986. A new body, the Financial Services Authority (FSA), was

established to take over the role of the Securities Investment Board (the body that was charged with overall responsibility for ensuring compliance with the Financial Services Act 1986). When the FSMA 2000 came fully into force on 1 December 2000, the FSA was placed centre stage as the primary supervisory organ for financial services. Although the new Act preserves the notion of self-regulation for general insurance business, the supervision of life business remains stricter, as it was under the 1986 Act, in that intermediaries are required to obtain authorisation by the FSA to conduct ‘regulated activities’ which includes dealing in or arranging deals for others in ‘contractually based investments’ (ie long term insurance). Many of the provisions found in the Insurance Companies Act 1982 together with the marketing rules that applied to investment businesses developed under the 1986 Act are replicated in the FSMA 2000. In essence, there are two types of insurance intermediary: independent intermediaries and tied agents. The latter type may sell life policies with only one insurance group, or, in the case of general insurance products, with up to six insurers. Independent intermediaries, on the other hand, are free to deal with any insurer. Prior to the FSMA 2000 only independent agents who chose to register as ‘insurance brokers’ under the Insurance Brokers (Registration) Act 1977 (repealed by the FSMA 2000 on 30 April 2001) were subject to a statutory regulatory regime in the form of the Code of Conduct promulgated by the Insurance Brokers Registration

Council. Registered insurance brokers had to satisfy financial, accounting and business requirements and maintain professional indemnity insurance (see John Lowry and Philip Rawlings, Insurance Law: Doctrines and Principles (Oxford, Hart Publishing, 1999) 337 et seq). The Code continues to be applicable to those who are members of the Institute of Insurance Brokers and subject to the Insurance Brokers Regulatory Council, an alternative regulatory body (and competitor) to the General Insurance Standards Council (see below). Independent intermediaries who did not call themselves ‘insurance brokers’, opting instead for titles such as ‘insurance advisers’, ‘insurance agent’ or ‘insurance consultants’, were outwith the 1977 Act. Such agents were subject to a self-regulatory scheme issued by the Association of British Insurers: General Insurance Business — Code of Practice for all Intermediaries (Including Employees of Insurance Companies) other than Registered Insurance Brokers (the revised version took effect in January 1989). The ABI Code also applied to tied agents and, as its title suggests, to employees of particular insurers. It also encompassed incidental intermediaries such as building societies, banks, travel agents, car dealers, utility companies, retailers (note that ‘incidental’ should not be equated with some minor activity: Dixons plc’s practice of selling extended warranties to customers purchasing electrical products from its stores generates approximately £100 million in profits and is currently the subject of a Competition Commission inquiry), and others who sold insurance

incidentally to carrying on their principal business. Further, incidental agents such as solicitors and accountants who sold investment products were required by the Financial Services Act 1986 to be independent or linked only to one insurer or marketing group. They could gain authorisation by a Recognised Professional Body provided their investment business did not exceed a certain threshold figure based on a percentage of their total business. The FSMA 2000 (Designated Professional Bodies) Order 2001 recognises, among others, the Law Society, the Institute of Chartered Accountants and the Association of Chartered Certified Accountants as designated professional bodies. For the government’s current thinking on such intermediaries, see the Treasury’s consultation paper, para 15 (below, [315]). Accredited Lloyd’s brokers, who enjoy a monopoly of placing business at Lloyd’s and placing reinsurance, were also regulated by the 1977 Act and therefore subject to the Insurance Brokers Registration Council’s Code of Conduct (albeit subject to stricter financial, accounting and indemnity insurance cover than was the case with registered insurance brokers). Additionally, Lloyd’s brokers are subject to the Lloyd’s Act 1982 (which is now supplemented by the FSMA 2000) and to the byelaws issued by the Council of Lloyd’s. The focus of the 1982 Act is on ensuring the independence of brokers from the managing agents of the syndicates with whom they place business.

3.1.1 General Council

Insurance

Standards

The initial approach of the Treasury was that the selling of general insurance, as opposed to life products, should not be subject to the FSA’s supervisory powers but rather the regulation of brokers and insurers dealing in general insurance would be overseen by a single, independent nonstatutory body namely, the General Insurance Standards Council (GISC). Membership is, for the time being, voluntary although Lloyd’s required all Lloyd’s brokers to become members with effect from 3 July 2000. Membership Rule F42 was fundamental to the cohesiveness of the new regime. It was drafted so as to prohibit a broker who was not a member of the GISC from transacting business with insurance companies that were members. The rule provided: ‘Subject to any Rule waiver issued by GISC, Members shall not, and shall ensure that their Appointed Agents and Appointed Sub-Agents shall not, in the course of their General Insurance Activities, deal directly with any person in circumstances which would involve that person in engaging in General Insurance Activities as an Intermediary where that person is not a Member.’

However, this rule was abandoned by the GISC when the Institute of Independent Insurance Brokers and the Association of British Travel Agents successfully challenged it as anti-competitive. In September 2001 the Competition Commission Appeal Tribunal,

reversing the Director General of Fair Trading, ruled that it was an undertaking that had the effect of distorting competition in the general insurance business market in the UK. In the wake of this finding the Government announced in December 2001 that it would impose a statutory regime for regulating brokers. It now seems that as from the 14 January 2005 the work of the GISC will be taken over by the FSA so that both general and long term insurance selling will be ‘regulated activitities’ (Treasury Press Notice 18, 11/02/03).

3.1.2 Self-Regulation under the GISC Rules The current scheme of self-regulation is based on the GISC Rules that are incorporated in the Membership Contract between the member and the GISC. They are summarised in the following extract from the Journal of Business Law (the full text of the two GISC Codes follows below, see [303] and [304]): [301] Julian Burling, “The Impact of the GISC” [2001] JBL 646 — Two codes setting out minimum standards in General Insurance Activities, from advice, through placing, to claims — one code for Private Customers and a less prescriptive code for Commercial Customers.

— E-commerce practice requirements and guidance on the provision of information or services to Private Customers through the internet. — Financial requirements for Intermediaries, comprising — insurance money segregation requirements, under which premiums and claims received on behalf of Customers (“Insurance Monies”) are to be paid into Insurance Bank Accounts, similar to the insurance broking accounts previously required by the IBRC and by Lloyd’s (but there is no requirement to segregate insurance moneys where the Intermediary is regulated by a recognised regulatory or professional body whose requirements provide an equivalent level of protection for Insurance Monies, or where the GISC is satisfied that the General Insurance Activities of the Intermediary are secondary to the main business activity of the Intermediary, or in certain other exceptional cases); professional indemnity insurance covering the General Insurance Activities of the Intermediary and its Appointed Agents and Appointed Sub-Agents; and solvency requirements for those Intermediaries required to segregate Insurance Monies. — Requirements as to the handling by Members of Customers’ complaints and, where necessary, the referral of such complaints to an “Approved Dispute Resolution Facility”, ie the Insurance Ombudsman Scheme, Financial Ombudsman Service, GISC Dispute Resolution Scheme or other approved dispute resolution schemes. — Competence and training requirements applicable to the employees of Members or of their Appointed Agents or Appointed Sub-Agents where they are acting on behalf of the Member. The Chartered Insurance Institute has been appointed as an accredited training provider; and

—

the new hundred multiple choice question “Foundation Insurance Test” will cover all insurance sellers from exhaust fitters to full-time insurance salesmen. Monitoring investigation and enforcement rules monitoring will be carried out by PwC and Ernst & Young on behalf of GISC. For the time being the emphasis will be on correction rather than punishment. GISC say that monitoring has so far been quite successful, cordial and constructive. Disciplinary action can be taken by the Enforcement Committee. No disciplinary proceedings have yet been instituted, although some warnings have been given. A Member may be ordered to pay compensation to a Private Customer, not exceeding £100,000 for any single act of misconduct. The Enforcement Committee may also intervene by means of Intervention Orders specifying steps which a Member is required or forbidden to take as to entering into specified transactions or disposing of or dealing with specified assets.

Note: The scope of the General Insurance Code and the role of the GISC are described in a leaflet published by the Council in 2000: [302] General Insurance Standards Council: New Insurance Watchdog (Leaflet Issued by the GISC 08/2000/COM008) ‘What is general insurance? General insurance covers products such as: — insurance for your home (buildings and contents), vehicles, caravans, boats and pets; — travel insurance;

—

private medical, dental and personal accident insurance; — extended warranty and breakdown insurance., — legal expenses insurance; and — payment protection for mortgages and other loans., but does not include life assurance and pensions. Important protection for you The GISC code sets out standards of good practice which all our members must follow when they deal with you. It gives you important protection and should help you to understand: — how our members must deal with you; — what information you should receive before you commit yourself to buying any insurance; and — how your insurance should be dealt with once you are covered. If the member fails to meet the standards of the code, and you suffer as a result, you have the right to complain under an independent complaints scheme which all our members must follow. Our members are monitored independently of GISC to make sure they follow the standards in the GISC code. What you should expect from GISC members Our members will: — act fairly and reasonably when they deal with you; — make sure that all their services meet our standards; — give you clear information on services and products before you buy, and after they confirm, your insurance; — make sure you have all the documents you need; — protect any personal information, money and property that they hold or handle for you., — handle claims fairly and quickly;

— give you advice on how to complain, if you need to; and — correct mistakes and handle complaints quickly. The full code explains these standards. If you would like a copy of the full code, please ask your insurer or anyone dealing with your insurance… The General Insurance Standards Council (GISC) is an independent organisation which regulates the sales, advisory and service standards of members (insurers and anyone dealing with your insurance). Its main purpose is to make sure that general insurance customers are treated fairly and properly.’

Notes: 1. As commented above, the GISC Rules encompass two Codes that lay down minimum standards for all insurers and intermediaries engaged in ‘General Insurance Activities’. 2. There is one code for private customers, the General Insurance Code, and one for nonconsumers, the Commercial Code. [303] The GISC General Insurance Code for Private Customers ‘The General Insurance Standards Council (GISC) The General Insurance Standards Council (GISC) is an independent organisation which was set up to regulate the sales, advisory and service standards of members (insurers, intermediaries (including brokers) and agents and anyone acting for them). Its main purpose is to make sure that general insurance customers are treated fairly. The Private Customer Code

This Private Customer Code sets the minimum standards of good practice which all members of GISC must follow when they deal with private customers. It gives you important protection and should help you to understand: — how insurers, intermediaries and agents, and anyone acting for them, must deal with you; — what information you should receive before you commit yourself to buying any insurance; and — how your insurance should be dealt with once it is in place. Insurance products and services covered by the Private Customer Code The Private Customer Code covers all types of general insurance products and services that are sold to private customers, including: — motor insurance; — home insurance — buildings and contents; — insurance for caravans, boats, pets and other property; — travel insurance; — private medical and dental insurance; — personal accident insurance; — extended warranty and breakdown insurance; — legal expenses insurance; and — payment protection insurance for mortgages and other loans. Understanding the Private Customer Code Within the Private Customer Code, ‘you’ means the private customer and ‘we’ and ‘us’ means the member of GISC (an insurer, intermediary or agent), and anyone acting for them, who you deal with… 1 OUR COMMITMENTS 1.1 As members of GISC, we promise that we will: — act fairly and reasonably when we deal with you;

— make sure that all our general insurance services satisfy the requirements of this Private Customer Code; — make sure all the information we give you is clear, fair and not misleading; — avoid conflicts of interest or, if we cannot avoid this, explain the position fully to you; — give you enough information and help so you can make an informed decision before you make a final commitment to buy your insurance policy; — confirm your insurance arrangements; — make sure that our service meets GISC’s standards; — handle claims fairly and promptly; — make sure you receive all the documentation you need; — protect any personal information, money and property that we hold or handle for you; and — handle complaints fairly and promptly. 2 MARKETING Advertising 2.1 We will make sure that all our advertising and promotional material is clear, fair and not misleading. 3 HELPING YOU FIND INSURANCE TO MEET YOUR NEEDS We will give you enough information and help so you can make an informed decision before you make a final commitment to buy your insurance policy. Explaining our service 3.1 We will explain the service we can offer and our relationship with you, including: — the type of service we offer; — whether we act for an insurer or act independently for you as an intermediary;

— whether we act as an agent of another intermediary or agent; and — the choice of products and services we can offer you. Matching your requirements 3.2 We will make sure, as far as possible, that the products and services we offer you will match your requirements: — If it is practical, we will identify your needs by getting relevant information from you. — We will offer you products and services to meet your needs, and match any requirements you have. — If we cannot match your requirements, we will explain the differences in the product or service that we can offer you. — If it is not practical to match all your requirements, we will give you enough information so you can make an informed decision about your insurance. Information about products and services 3.3 We will explain all the main features of the products and services that we offer, including: — who the insurer is; — all the important details of cover and benefits; — any significant or unusual restrictions or exclusions; — any significant conditions or obligations which you must meet; and — the period of cover. Information on costs 3.4 We will give you full details of the costs of your insurance, including: — separate insurance premiums for each of the individual products or services we are offering; — details of any fees and charges other than the insurance premium, and the purpose of each fee or charge (this will include any possible future fees or

charges, such as for changing or cancelling the policy or handling claims); — when you need to pay the premiums, fees and charges, and an explanation of how you can pay; and — if we are acting on your behalf in arranging your insurance, if you ask us to, we will tell you what our commission is and any other amounts we receive for arranging your insurance or providing you with any other services. Advice and recommendations 3.5 If we give you any advice or recommendations, we will: — only discuss or advise on matters that we have knowledge of, — make sure that any advice we give you or recommendations we make are aimed at meeting your interests; and — not make any misleading claims for the products or services we offer or make any unfair criticisms about products and services that are offered by anyone else. Customer protection information 3.6 We will explain the customer protection benefits under our GISC membership, including: — our complaints procedures, together with details of who you should contact first if you want to make a complaint; and — whether any of the products or services we are offering you are not covered by this Private Customer Code. Your duty to give information 3.7 We will explain your duty to give insurers information before cover begins and during the policy, and what may happen if you do not.

Quotes 3.8 If you want to consider the products or services we have offered you, we will: — confirm how long you have to take up your insurance on the terms we have quoted to you; — give you a written quote if you ask for one, including all the information you need to make an informed decision; and — give you a sample policy if you ask for one. Cooling-off period 3.9 Under the Private Customer Code, we have to give you certain information before you make your decision. If we have not given you this information when you buy your insurance (and you have not told us you do not want it), we will allow you a ‘cooling-off period’ of at least 14 days from the time you receive the information. If you do not want to continue with the insurance, you may cancel your cover within this period and get all your money back (as long as you have not made any claims). Choosing to receive limited information 3.10 If you want to buy your insurance without receiving all the information about the products and services that the Private Customer Code requires, we will keep a record of your agreement to this and there will not be a ‘coolingoff’ period. 4 CONFIRMING YOUR COVER We will confirm your insurance arrangements and provide you with full policy documentation. Confirming your cover 4.1 When we put your insurance arrangements in place, we will give you written confirmation of cover, including: — enough information so you can check the details of your cover;

— the date when your cover starts and the period of cover; — any certificates or documents which you need to have by law and — details of any ‘cooling-off’ period. Proof of payment 4.2 We will make sure that you have proof that you have paid the premiums, fees and charges. Full policy documents 4.3 We will send you full policy documentation promptly. 5 PROVIDING OUR SERVICE TO YOU We will make sure that our service meets the GISC’s standards. Questions 5.1 We will answer any questions promptly and give you help and advice if you need it. Changes to your policy 5.2 We will deal with any changes to your insurance policy promptly. We will: — give you written confirmation of any changes to your policy; — give you full details of any premiums or charges that you must pay or we must return to you; — give you any certificates or documents that you need to have by law; — make sure that you have proof that you have paid extra premiums, fees and charges; and — send you any refunds of the premiums, fees or charges that are due to you. Notice of renewal 5.3 We will tell you when you need to renew your policy, or that it will end, in time to allow you to consider and

arrange any continuing cover you may need. We will: — explain the renewal terms (if offered); — tell you about any changes to the cover, service or insurer being offered; — explain your continuing duty to give insurers information; and — send you any certificates or documents that you need to have by law. Expiry or cancellation 5.4 When your policy ends or is cancelled, we will send you all the documentation and information that you are entitled to, if you ask for it. 6 CLAIMS We will handle claims fairly and promptly. Information on claims procedures 6.1 When you first become a customer, we will give you details of how you can make a claim and tell you what your responsibilities are in relation to making claims. If you make a claim 6.2 If you make a claim: — we will respond promptly, explain how we will handle your claim and tell you what you need to do; — we will give you reasonable guidance to help you make a claim under your policy; — we will consider and handle your claim fairly and promptly, and tell you how your claim is progressing; — we will tell you, in writing, and explain why, if we cannot deal with all or any part of your claim; and — once we have agreed to settle your claim, we will do so promptly. 7 DOCUMENTATION

We will make sure you documentation you need.

receive

all

the

correct

Information in writing 7.1 We will give you information in writing, especially if there is a lot of information or if it is very complicated. Standards of written information 7.2 We will make sure that all the written information and documents we send you are clear, fair and not misleading. Sending you documentation 7.3 We will send you all the documentation you need promptly. Withholding documentation 7.4 We will not withhold any insurance documentation from you without your permission, unless we are allowed to do so by law. If we do withhold any documents, we will make sure that you receive full details of your insurance cover and any documents that you need to have by law. 8 CONFIDENTIALITY AND SECURITY We will protect your personal information, money and property. Confidentiality 8.1 We will treat all your personal information as private and confidential to us and anyone else involved in providing your insurance, even when you are no longer a customer. We will not give anyone else any personal information about you, except: — when you ask us to or give us permission; — if we have to because we are a member of GISC; or — if we have to by law. Security

8.2 We will take appropriate steps to make sure that any money, documents, other property or information that we handle or hold for you is secure. 9 COMPLAINTS We will handle complaints fairly and promptly. Information on complaints procedures 9.1 When you first become a customer, we will give you details of our complaints procedures in our policy or service documentation. If you make a complaint 9.2 If you make a complaint: — we will acknowledge it promptly, explain how we will handle your complaint and tell you what you need to do; and — we will consider and handle your complaint fairly and promptly, and tell you how your complaint is progressing. Dispute resolution scheme 9.3 We are a member of a recognised independent dispute resolution scheme. If you are not happy with our final response to your complaint, we will tell you how you can contact this scheme. 10 OTHER INFORMATION GISC monitoring 10.1 We are monitored independently by GISC to make sure that we meet the standards of this Private Customer Code. If we do not satisfy the requirements of the Private Customer Code, we may face a penalty. The Private Customer Code and your legal rights 10.2 The Private Customer Code forms part of the Membership Contract (which is governed by English law)

between GISC and us. Nothing in the Private Customer Code or in our Membership Contract with GISC will give any person any right to enforce any term of our Membership Contract which they would otherwise have under the Contracts (Rights of Third Parties) Act 1999. Copies of the Private Customer Code 10.3 You can get a free a copy of the Private Customer Code if you ask any GISC member, or from GISC at the address below. More information 10.4 If you want to check that we are members of GISC, or if you have any questions about the Private Customer Code, you can contact GISC at the address below. General Insurance Standards Council 110 Cannon Street London EC4N 6EU Telephone: 020 7648 7810 Fax: 020 7648 7808 Email (general enquiries): [email protected] Or, you can access the GISC website at: www.gisc.co.uk’

Notes: 1. The Private Customer Code is drafted in the second person, addressed to the insured, taking the form of a series of promises (para 10.2 excepted). As such, it is possible that the Code will be incorporated into the contract between the intermediary and the insured person. 2. Just as the Insurance Ombudsman took account of the ABI code in his deliberations, no doubt he will be similarly aware of the content of the

GISC Code and ‘equally influenced’ by its content’ (J Burling, (above, [301]). 3. The Commercial Code contains similar principles to the General Insurance Code but is directed towards the non-consumer insured. [304] The GISC Commercial Code (Effective from 3 July 2000) ‘Words in italics are defined terms, in accordance with the GISC Rules. INTRODUCTION Within this Commercial Code ‘Member’ means a Member of GISC (an Insurer, Intermediary (including broker) or agent), and anyone acting on its behalf, with whom the Commercial Customer deals. CORE PRINCIPLES In the course of their General Insurance Activities Members should: 1.1 act with due skill, care and diligence; 1.2 observe high standards of integrity and deal openly and fairly with their Commercial Customers; 1.3 seek from Commercial Customers such information about their circumstances and objectives as might reasonably be expected to be relevant in enabling the Member to fulfil their responsibilities to them; 1.4 take reasonable steps to give Commercial Customers sufficient information in a comprehensible and timely way to enable them to make balanced and informed decisions about their insurance; 1.5 take appropriate steps to safeguard information, money and property held or handled on behalf of Commercial Customers;

1.6 conduct their business and organise their affairs in a prudent manner; 1.7 seek to avoid conflicts of interest, but where a conflict is unavoidable or does arise, manage it in such a way as to avoid prejudice to any party. Members will not unfairly put their own interests above their duty to any Commercial Customer for whom they act; and 1.8 handle complaints fairly and promptly. PRACTICE NOTES 1 It is GISC’s intention to promote standards of professional conduct for Members. These Practice Notes represent statements of reasonable practice which Members will be expected to follow generally in adhering to the Core Principles. 2 A failure on the part of a Member to observe the standards set out in these Practice Notes shall not of itself constitute a breach of the Rules but any such failure may in disciplinary proceedings be relied upon by GISC or any party to the proceedings as tending to establish or to negate any liability which is in question in those proceedings. MARKETING 3 Members will ensure that all their advertising and promotional material is clear, fair and not misleading. ARRANGING THE INSURANCE Commercial Customer relationship 4 Members will advise their Commercial Customers of the nature of their service and their relationship with them, in particular, whether they act on behalf of an Insurer or act independently on behalf of the Commercial Customer as an Intermediary. They will also make it clear if they operate as an agent of another Intermediary.

5 Members will, where it is reasonably practical, confirm in writing instructions to act on behalf of a Commercial Customer and this will include appropriate reference to any recommendations made by the Member but declined by the Commercial Customer. Commercial Customer requirements 6 Members will take appropriate steps to understand the types of Commercial Customers they are dealing with and the extent of their Commercial Customers’ awareness of risk and General Insurance Products and take that knowledge into account in their dealings with them. 7 Members will seek from Commercial Customers such information about their circumstances and objectives as might reasonably be expected to be relevant in enabling them to identify the Commercial Customer’s requirements and fulfil their responsibilities to their Commercial Customers. Information about proposed insurance 8 Members will provide adequate information in a comprehensive and timely way to enable Commercial Customers to make an informed decision about the General Insurance Products or General Insurance Activity-related services being proposed. 9 If they are acting on behalf of the Commercial Customer, Members will explain the differences in, and the relative costs of, the types of insurance, which in the opinion of the Member, would suit the Commercial Customer’s needs. In so doing, Members will take into consideration the knowledge held by their Commercial Customers when deciding to what extent it is appropriate for their Commercial Customers to have the terms and conditions of a particular insurance explained to them.

10 Members will advise Commercial Customers of the key features of the significant or unusual restrictions, exclusions, conditions or obligations, and the period of cover. In so doing, Members will take into consideration the knowledge held by their Commercial Customers when deciding to what extent it is appropriate for Commercial Customers to have the terms and conditions of a particular insurance explained to them. 11 If Members are unable to match Commercial Customers’ requirements they will explain the differences in the insurance proposed. Advice and recommendations 12 Members should only discuss with or advise Commercial Customers on matters in which they are knowledgeable and seek or recommend other specialist advice when necessary. 13 Members will take reasonable steps to advise Commercial Customers if any General Insurance Products or General Insurance Activity related services being offered or requested are not covered by this Commercial Code and any possible risks involved. In so doing, Members will take into consideration the knowledge held by their Commercial Customers in deciding to what extent such advice may be necessary. Information about costs and remuneration 14 Members will provide details of the costs of each General Insurance Product or General Insurance Activity — related service offered. 15 Members will not impose any fees or charges in addition to the premium required by the Insurer without first disclosing the amount and purpose of the charge. This will include charges for policy amendments, claims handling or cancellation.

16 Members who are acting on behalf of a Commercial Customer in arranging their insurance will, on request, or where they are legally obliged to do so, disclose the amount of commission and any other remuneration received for arranging the insurance. 17 Members will disclose to Commercial Customers any payment they receive for providing to, or securing on behalf of, their Commercial Customers any additional General Insurance. Duty of disclosure 18 Members will explain to Commercial Customers their duty to disclose all circumstances material to the insurance and the consequences of any failure to make such disclosures, both before the insurance commences and during the policy. 19 Members will make it clear to Commercial Customers that all answers or statements given on a proposal form, claim form, or any other material document, are the Commercial Customer’s own responsibility. Commercial Customers should always be asked to check the accuracy of information provided. 20 If Members believe that any disclosure of material facts by their Commercial Customers is not true, fair or complete, they will request their Commercial Customers to make the necessary true, fair or complete disclosure, and if this is not forthcoming must consider declining to continue acting on their Commercial Customer’s behalf. Quotations 21 When giving a quotation, Members will take due care to ensure its accuracy and their ability to place the insurance at the quoted terms. Placement 22 Members who act on behalf of Commercial Customers when arranging their insurance will use their skill

objectively in the best interests of their Commercial Customers when choosing Insurers. 23 Where two or more Members are acting jointly for a Commercial Customer when placing an insurance, Members will take appropriate steps to see that they and their Commercial Customers know their individual responsibilities and duties. 24 Members will inform and seek from their Commercial Customers written acknowledgement where they are instructed to place an insurance which is contrary to the advice that has been given by the Member. CONFIRMING COVER 25 Members will provide Commercial Customers with prompt written confirmation and details of the insurance which has been effected on their behalf. 26 Members will identify the Insurer(s) and advise any changes once the contract has commenced at the earliest opportunity. 27 Members will forward full policy documentation without avoidable delay where this is not included with the confirmation of cover. 28 29

30 31 32

PROVIDING ONGOING SERVICE Members will respond promptly to Commercial Customers’ queries and correspondence. Members will deal promptly with Commercial Customers’ requests for amendments to cover and provide them with full details of any premium or charges to be paid or returned. Members will provide written confirmation when amendments are made. Members will remit any return premium and charges due to Commercial Customers without avoidable delay. Members will notify Commercial Customers of the renewal or expiry of their policy in time to allow them to

consider and arrange any continuing cover they may need. 33 Members will remind Commercial Customers at renewal of their duty to disclose all circumstances material to the insurance. 34 On expiry or cancellation of the insurance, at the written request of the Commercial Customer, Members will promptly make available all documentation and information to which the Commercial Customer is entitled.

35 36 37 38

CLAIMS Where Members handle claims: Members will, on request, give their Commercial Customers reasonable guidance in pursuing a claim under their policy. Members will handle claims fairly and promptly and keep their Commercial Customers informed of progress. Members will inform Commercial Customers in writing, with an explanation, if they are unable to deal with any part of a claim. Members will forward settlement of a claim, without avoidable delay, once it has been agreed.

DOCUMENTATION 39 Members will reply promptly or use their best endeavours to obtain a prompt reply to all correspondence. 40 Members will forward documentation without avoidable delay. 41 Members should not withhold from their Commercial Customers any written evidence or documentation relating to their contracts of insurance without their consent or adequate and justifiable reasons being disclosed in writing and without delay. If Members withhold a document from their Commercial Customers

by way of a lien for monies due from those Commercial Customers they should provide advice of this to those Commercial Customers in writing at the time that the documents are withheld. If any documentation is withheld Members will ensure that Commercial Customers receive full details of the insurance cover and any documents to which they are legally entitled. CONFLICTS OF INTEREST 42 Members will seek to avoid conflicts of interest, but where this is unavoidable, they will explain the position fully and manage the situation in such a way as to avoid prejudice to any party. 43 Members will not put their own interests above their duty to any Commercial Customer on whose behalf they act. CONFIDENTIALITY AND SECURITY 44 Members will ensure that any information obtained from a Commercial Customer will not be used or disclosed except in the normal course of negotiating, maintaining or renewing insurance for that Commercial Customer, unless they have their Commercial Customer’s consent, or disclosure is made to enable GISC to fulfil its regulatory function, or where the Member is legally obliged to disclose the information. 45 Members will take appropriate steps to ensure the security of any money, documents, other property or information handled or held on behalf of Commercial Customers. COMPLAINTS 46 Members will provide details of their complaints procedures to Commercial Customers, and details, if appropriate, of any dispute resolution facility which is available to them. 47 Members will handle complaints fairly and promptly.

COMMERCIAL CODE 48 Members will provide, on request, a copy of this Commercial Code to Commercial Customers or anyone acting on their behalf. 49 The Commercial Code forms part of the Membership Contract between Members and GISC which is governed by English law. Nothing in the Commercial Code or in the Membership Contract between Members and GISC will give any person any right to enforce any term of the Membership Contract between Members and GISC (including the Commercial Code) which that person would not have had but for the Contracts (Rights of Third Parties) Act 1999.’

3.1.3 The Proposed 2005 Statutory Structure The EC Commission, as part of its 1992 Single Market programme, indicated in a Recommendation, Professional Requirements and Registration of Insurance Intermediaries (92/48/EEC, 18 Dec 1991, OJL 28.1.92), that it was considering EU-wide legislation designed to harmonise the regulation of insurance intermediaries. In 1997 the Commission announced that it was considering a draft directive on the matters covered by its Recommendation and a consultation process was launched. This culminated in the Insurance Mediation Directive, European Parliament and Council Directive 2002/92/EC being adopted on 9 December 2002. Because of the delay in the publication of the Directive (it was not published until January 2003, [2003] OJ L9/3)), the

Treasury announced that the new statutory scheme for regulation would not come into force until 14 January 2005 (see the Treasury Press Notice 18, above). The implementing statutory instruments are the Insurance Mediation Directive (Miscellaneous Amendments) Regulations 2003 (SI 2003 No 1473) and the FSMA 2000 (Regulated Activities) Amendment (No 2) Order 2002 (SI 2003 No 1476). The new regime that will implement the Mediation Directive will place general insurance under the supervision of the FSA. All insurance intermediaries conducting business in the EU will have to be registered by a competent authority (subject to certain exceptions, for example, employees of insurance companies: Article 2.2 (insurance companies, as employers, must be authorised and accept responsibility for the acts of their employees). Further, those who sell travel insurance as part of a package with a holiday are also excluded: Article 1.2. The position relating to extended warranties will not be determined until after Competition Commission completes its investigation into this market, (late 2003). Obtaining registration will be subject to meeting certain requirements relating to (i) professional knowledge and skill (determined by national law), (ii) character and (iii) maintaining professional indemnity insurance for at least Euro1,000,000 per claim: Article 4. A registered insurance intermediary will be permitted to pursue his or her activities anywhere in the EU either through establishment in a member state or by providing cross-border services: Article 3.

The government’s proposals for implementing the Directive into UK law were set out in its consultation paper published on 21 October 2002. The intention was to give the FSA responsibility for regulating the following activities: introducing, proposing or carrying out other work preparatory to the conclusion of contracts of insurance; concluding contracts of insurance; and assisting in the administration and performance of such contracts, in particular in the event of a claim (see the Executive Summary, para 9 (below, [305])). As indicated above, the Insurance Mediation Directive (Miscellaneous Amendments) Regulations 2003 (SI 2003 No 1473) and the FSMA 2000 (Regulated Activities) Amendment (No 2) Order 2002 (SI 2003 No 1476) now implements these proposals. [305] HM Treasury, Regulating Insurance Mediation, Consultation Document ‘EXECUTIVE APPROACH

SUMMARY

THE

GOVERNMENT’S

Background 1. This consultation document sets out the Government’s intended approach to regulating the sale of general insurance products. FSA regulation will enhance consumer protection in an important sector of financial business. The UK has the largest insurance industry in Europe. In 2000 over £150 billion of general and long term premiums were written. 2. These measures will in some cases simplify and streamline regulation. The FSA will be given

responsibility for regulating both mortgage business and the mediation of general insurance from the same date, October 2004, (although this may be reviewed if there is a significant delay in publication of the Insurance Mediation Directive in the Official Journal of the European Communities) [see above, the proposed date is 14 January 2005]. Intermediaries selling a range of products — general insurance, pensions, or mortgages — will come under the FSA as single regulator, minimising compliance costs. The measures in this document, together with forthcoming FSA rules, will also implement the European Union’s Insurance Mediation Directive. This is a key step in completing the single market in financial services. 3. The consultation document sets out the Government’s proposals on a range of issues: — Chapter 1 gives further background to the Government’s intended approach and sets out the principal steps towards the introduction of regulation. A detailed timetable is included at Annex B; — Chapter 2 sets out which contracts of insurance will be regulated and where the Directive provides exclusions; — Chapter 3 details the activities the Treasury intends to regulate. Annex C contains decision trees which will help readers determine whether they are likely to be carrying on activities to be regulated; — Chapter 4 explains how the Treasury intends to modify the regulatory regime for appointed representatives and members of certain professional bodies and also covers a range of other issues including Lloyd’s and issues of territorial scope; — Chapter 5 summarises the requirements of regulation for those authorised by the FSA.

Which contracts of insurance will be regulated? 4. The Directive requires the regulation of mediation activities in relation to all contracts of insurance. However the Directive provides certain exemptions for insurance sold as part of a package. 5. Sales of travel insurance as a stand alone product will be regulated. But the Directive does not require regulation of travel insurance sold as part of a package with a holiday. The Government is considering whether to extend regulation to these sales of travel insurance, and is seeking views on three options: — no statutory regulation of sales of travel insurance sold as part of a package; — FSA regulation to cover these sales in the same way as stand alone sales of travel insurance; — industry specific regulation, requiring sellers of these products to be authorised by the FSA unless they are subject to an ABTA code which would be certified by the FSA. Sellers who were subject to the ABTA code but who also carried on other FSMA regulated activity, including selling any insurance other than packaged travel insurance, would be subject to FSA authorisation in relation to all of their regulated activities (including the activities to which the ABTA code applied). 6. The Directive similarly provides an exclusion for extended warranties provided certain conditions are met, including that the warranty is for less than Euro 500 (about £300) per annum. Whilst most extended warranties for motor vehicles will be covered by the Directive, those with a value of less than Euro 500 are excluded. However the Government intends that the new regime should cover all extended warranties for motor vehicles, including those which fall below the exemption threshold of E500. This is to avoid market

distortions which might occur if some warranties for motor vehicles were regulated and some were not. 7. Various concerns about extended warranties of domestic electrical appliances have resulted in the Office of Fair Trading (OFT) asking the Competition Commission to investigate this market. The Commission expects to report in the second half of 2003. The Government intends to postpone a decision as to whether extended warranties for electrical goods and other goods such as jewellery and carpets should be subject to regulation by the FSA until after the Competition Commission reports. 8. For more details on the scope of regulation, see Chapter 2 of this document. Which activities will be regulated? 9. The Government intends to give the FSA responsibility for regulating the following activities: — introducing, proposing or carrying out other work preparatory to the conclusion of contracts of insurance; — concluding contracts of insurance; and — assisting in the administration and performance of such contracts, in particular in the event of a claim; 10. However claims handling on behalf of insurance companies, expert appraisal and loss adjusting are excluded from the activities the Directive requires us to regulate. The Government does not intend to bring these activities within the scope of FSA regulation. 11. For more details on the activities to be regulated see Chapter 3. Who will be regulated? 12. Individuals, partnerships or companies who want to carry on insurance mediation activity “by way of business” will have to apply to the FSA in order to be “authorized” to do so. The FSA will be consulting on the

13.

14.

15.

16.

requirements for authorisation shortly. Firms already authorised by the FSA for other regulated activities who want to carry on insurance mediation activity “by way of business” will need to apply to the FSA for a variation of their permission. The Directive does not require regulation of direct sales by employees of insurance companies. However the Government intends to regulate mediation activities carried on by employees of insurers in order to ensure clarity for the consumer and to avoid creating an unlevel playing field between insurers and intermediaries. Appointed representatives of FSA authorised persons can carry on regulated activities without being authorised provided the authorised person has accepted responsibility for the conduct of those regulated activities. The Government intends to apply the appointed representatives regime to insurance mediation with the necessary modifications to make it compatible with the requirements of the Directive. Members of Designated Professional Bodies (DPBs), such as accountants and solicitors can carry on certain regulated activities where those activities are incidental to their main profession, without being authorised by the FSA. Such persons must comply with the rules of their DPB. The Government intends to apply this regime to insurance mediation activities with the necessary modifications to make it compatible with the requirements of the Directive. For more details on who will be regulated and how, see Chapter 4.

What will the requirements of regulation be? 17. Most individuals or companies who want to carry on insurance mediation activity by way of business will have to apply to the FSA in order to be “authorised” to

18.

19.

20.

21.

carry on such business. In order to become an “authorised person” various requirements have to be met including being a “fit and proper person”. The FSA will require those carrying on insurance mediation activities to disclose to the customer certain information prior to concluding, amending or renewing a contract of insurance. The Directive imposes certain minimum pre-sale information requirements but it will be open to the FSA to adopt additional safeguards. The Directive requires the UK to set up procedures allowing customers and other interested parties (including consumer associations) to register complaints about insurance and reinsurance intermediaries. The Directive also requires the UK to take measures to protect customers against the inability of the insurance intermediary to transfer the premium to the insurance undertaking, or to transfer the amount of claim or return premium to the insured. It will be for the FSA to implement these provisions. The Government intends to make insurance mediation activities regulated activities under FSMA, which means that a person who carries on these activities without being authorised or exempt would commit a criminal offence’ [see section 19 of the FSMA 2000]. The FSA has a range of sanctions against authorised persons including the ability to issue fines, and statements of public censure. Authorised persons can challenge the decisions of the FSA in the Financial Services and Markets Tribunal (“the Tribunal”). For more details on the requirements of regulation, see Chapter 5.

Note: The effect of the proposed statutory scheme of regulation will, therefore, place the regulation of

general insurance intermediaries on the same footing as that for life intermediaries. The current regime for life intermediaries is regarded by the Treasury as satisfying the requirements of the Directive.

3.2 The Authority of Intermediaries The general law of agency applies to insurance intermediaries. Thus, a principal will be bound by an agent’s acts carried out within the scope of his or her actual or apparent authority.

3.2.1 Actual Authority The extent of an intermediary’s actual authority can be ascertained from the express agreement between him or her and the principal. Actual authority is supplemented by an agent’s implied authority to do what is reasonably incidental to the carrying out of those acts which are expressly authorised: a common example is the implied authority of an agent to enter into interim insurance contracts by issuing cover notes on behalf of the insurer. [306] Stockton v Mason and the Vehicle and General Insurance Co Ltd [1978] 2 Lloyd’s Rep 430 (CA) [The facts appear from Diplock LJ’s judgment]. Diplock LJ:

‘This appeal arises out of a motor accident which took place at 3 30 p.m. — the time is of importance — upon 18 April 1968, when an MG Midget motor car driven by the defendant had an accident in which the plaintiff, who was a passenger, sustained very serious physical injuries. It is not disputed that that was as a result of the driver’s negligence. The driver was the defendant in this action. The damages were assessed at £46,000. The only question in this appeal is one which raises a point of insurance law. The car was the property of the defendant’s father, a Mr Mason. He had previously had policies of insurance for cars which he had owned earlier. Those insurance policies were issued by the first third party as insurers. The negotiations for the previous policies had been conducted through the second third party as insurance brokers for Mr Mason, the father. The point of insurance law on which this appeal turns arises out of the tripartite legal relationship between an insurance broker, the insurer and the assured in the field of non-marine insurance. The principle of law involved in this relationship is one which is well established so far as the brokers’ agency on behalf of the insurers is concerned. A broker in non-marine insurance has implied authority to issue on behalf of the insurer or enter into as agent for the insurer contracts of interim insurance, which are normally recorded in cover notes. The essential nature of the contract of interim insurance is that it is for a temporary period, generally a maximum of 30 days or so, but is terminable by notice by the insurer at any time during that period. The implied authority of the broker does not extend to entering into the complete policy of insurance which is substituted for the temporary one and is for a fixed period. The facts of this case that I have necessarily to recount for the purposes of deciding the issues in this appeal can be stated shortly. I have already stated the date of the accident

and the time of it, 3 30 p.m. on 18 April 1968. Mr Mason, as I have said, had had previous policies of insurance for various cars which he had owned. They were all comprehensive policies. They covered passenger liability, and they also covered the liability of any authorised driver of the motor car concerned. In April — the exact date does not matter — Mr Mason exchanged a car which he had previously owned, a Ford Anglia, which was the subject of one of these policies of insurance, for an MG Midget; and on 8 April there was a conversation between Mr Mason’s wife, Mrs Mason, who acted on his behalf in these matters, with the brokers, the second third party. There was some dispute as to what the conversation was. The learned Judge found that it took this form: Mrs Mason explained that they had exchanged the Ford Anglia for the MG Midget, Mr Mason wished the MG Midget to be substituted for the Anglia as the car insured under the current policy of insurance; she gave all the necessary details from the log book of the MG Midget and explained that she wanted it substituted; and the employee of the brokers said to her — these are the exact words found by the learned Judge after an interval of getting on for seven or eight years: “Yes, that will be all right. We will see to that, Mrs. Mason.” That was all that happened on that occasion. Mrs Mason regarded that conversation as meaning that the insurance had been transferred to the new car in the same terms as before, covering both passenger liability and the driving of the car by any authorised driver. On 17 April the second third party wrote to Mr Mason a letter in the following terms:

“…With reference to your recent substitution to the M.G. Midget, we would advise you that before a cover note can be released to you we must be in receipt of: 1. The obsolete insurance certificate for the Ford Anglia. 2. Your remittance in the amount of £…2. 3. The attached additional drivers form duly completed as driving must be on a named and approved basis. We would therefore advise you that we have restricted driving to yourself only, and we now await your advices.” That is a plain departure from the cover given by the previous policy on the Anglia in that the letter excluded the driving by any authorised driver and was at the time limited to driving by Mr Mason himself. That letter was received, as the learned Judge found, by Mr and Mrs Mason at 5 15 p.m on 18 April; that is to say, after the accident had already occurred… In this appeal really the only question is whether there was in law established as a result of that conversation a contract of interim insurance between the insurers and Mr Mason. If there was, then the remedy of young Mr Mason, the defendant here, is against the insurers; if there was not, it is conceded that the brokers were negligent, and that the judgment of the learned Judge must stand. So it comes down to a very short point — whether those words, in reply to a request for substitution of the Midget for the Ford Anglia, “Yes, that will be all right. We will see to that, Mrs Mason”, were said as agent for the insurance company, or simply meant that the brokers, as agents for Mr Mason, would try and get the cover. Bearing in mind the ordinary relationship between brokers and insurance companies in non-marine insurance as respects the implied authority to enter into contracts of interim insurance and to issue cover notes, it seems to me to be quite unarguable that in saying “Yes, that will be all right. We will see to that, Mrs Mason” the brokers were

acting as agents for the insurance company and not merely acknowledging an order or a request by Mr Mason to negotiate a contract with the insurance company on his behalf. There must be every day thousands of cases, not only in motor insurance but in other forms of non-marine insurance, where persons wishing to become insured or wishing to transfer an insurance ring up their brokers and ask for cover or ask for fresh cover or ask to transfer the cover from an existing vehicle to another. In every case they rely upon the broker’s statement that they are covered as constituting a contract binding upon the insurance company. In that sort of conversation they are speaking, in the absence of any special circumstances, to the broker as agent for the insurance company, and the broker, in dealing with the matter, is acting as agent for the insurance company and not as agent for the person wishing to have insurance. Of course, there may be exceptional cases. There was nothing exceptional about this. A contract of insurance of this kind can be made orally, it can be made in informal, colloquial language, and this, in my view, is a very simple and clear example of that kind of legal situation. I would, therefore, allow this appeal. The effect of that is, I think, that the judgment must be against the first third party, the insurance company, and the judgment against the second third party, the brokers, must be discharged.’

[307] Murfitt v The Royal Insurance Company Ltd (1922) 10 Ll L Rep 191 [The facts appear from the judgment]. McCardie J: ‘This is an unusual case in the facts which give rise to this litigation, and the hypothesis on which I am invited to give

my judgment. The action is brought by Mr Murfitt against the Royal Insurance Company, a well-known company, and the plaintiff claims upon a verbal contract of insurance… The matter arises thus. The plaintiff is a nurseryman and fruit grower; and his holding is at March, Cambridgeshire, quite close to the line of the Great Eastern Railway. He has upon his land a quantity of valuable fruit trees and other fruit crops. Last year was exceptionally dry. Fires broke out even on fruit farms; and the plaintiff desired to insure his fruit farm against fire risks. In these circumstances he went on 16 July to see Mr Allwood, who was an agent of the defendant company, and the matter was discussed. Plaintiff said: “I want an insurance for £3,000 on my holding” (giving him details). “Will you do it at once or I must go elsewhere?” Allwood said: “We will do it for you and we will hold you covered until the office either accepts your proposal or turns it down.” Allwood added: “This cover I give you is on condition you promise not to approach any other office.” Plaintiff gave his promise, and then Allwood finally agreed to cover him. A discussion arose and Allwood said: “I do not know the premium: I will let you know later on.” It is upon that verbal bargain that the plaintiff founds his action. Allwood then went back to the office at Peterborough. It was Saturday afternoon. He did not then send on the proposal for the signature of the plaintiff: but the next day he did forward it. This was filled up with the necessary details and answers to the appropriate questions. The plaintiff signed this proposal and sent it back. The office at Peterborough got it on the Monday duly signed by the plaintiff. The manager of the Peterborough branch wrote on it the terms “18 July until March, 1922,” and sent it on to the Lincoln head office for consideration; and on 22 July a fire broke out in the plaintiff’s orchard and serious damage occurred. About 23 July, the defendant company refused to accept the proposal.

I make it clear at once that this was a well-known and important company; and at that time they were unaware that the fire had taken place. They refused it because it was not the class of insurance they desired to undertake. Plaintiff himself, at the time of the fire, was away. A few days later Mr Allwood, having heard of the refusal by the defendant company, saw the plaintiff and told him that the company had declined. Much correspondence took place; and ultimately the insurance company wrote the plaintiff and said they disputed the authority of Mr Allwood to give verbal cover. Now these are the broad facts… The first question I have to deal with is: Had Mr Allwood actual authority conferred upon him by express writing or express statement by word of mouth? I think the answer to that question is plainly No. The broad features of the defendants’ organisation are these. They have their chief head office in Liverpool. They have another head office in Lincoln; and they have what they call a branch office at Peterborough. The Peterborough manager is Mr Carter and the assistant manager is Mr Hammond. Mr Allwood is not one of the salaried officials of the company: he is what has been called a full agent. He was so appointed at the end of 1919; and the documents connected with his appointment state that every class of business is transacted by the Royal Insurance Co. Now what does a full agent mean? It has, in my view, a particular meaning in the insurance world. It does not mean that he is a salaried official: but it distinguishes between the full agent and the casual or intermittent agent. The casual agent pays over any premiums he may receive and at once gets his commission; while the full agent runs an account with the company, delivers his cash account quarterly for his premiums, and then gets his commission. That was the position of this agent, Mr Allwood. I am satisfied that there is no writing which gives him any authority to make an insurance; and I am satisfied there was

no verbal statement which gave him authority to make an insurance. Upon this point I have no doubt. The next question is this: Was there a holding out by the company of Mr Allwood as an agent with this authority to make this bargain. In my opinion there was no holding out at all. There had been previous transactions by the plaintiff with Mr Allwood as an agent of the defendants; and both these transactions related to motor-cycles. In each case a parallel arrangement to cover was made: but in each case a document was expressly given by the company in order to indicate that cover was given. One was a cover note and the other was a cover letter. With regard to motor-cycles, a book of forms was kept; and apparently there is no difficulty in getting the form of cover: but this was a wholly separate form of assurance, and it is a striking fact that throughout the whole of the books of the Royal Insurance Co. there is no trace of any prior insurance by them on fruit crops or the like. In my opinion there was no holding out at all by the insurance company upon which the plaintiff could rely as an estoppel against them. That leads me to the third point, which is one to which I have given particular attention. Has Mr Allwood implied authority to give a verbal cover? Let me be quite plain on the ground on which I am going to decide this point: there must be no misunderstanding about it. I hold, in the first place, that the decision in Linford v Provincial Co (34 Beav. 291) is a sound decision, and one fully applicable to the present case. I think that decides that an ordinary local agent of an insurance company is not — without special authority — authorised by the company to make a contract. I accept that decision fully. On the other hand, I have no doubt of the authority in the case of Mackie v European Assurance Society (21 LT 102). The effect of that decision is that if an insurance company gives to its agents a book of forms for making insurances, the agent will then have power to make a bargain upon the terms contained in the form.

That is the effect of the Mackie case. It turns on giving an agent a book of forms. Now, these two authorities I accept: but the present case is one in which the question arises as to whether or not Mr Allwood had, by the consent of the officials at Peterborough, implied authority. One fact is plain and undisputed; and that is that Mr Carter, the Peterborough manager, could give authority to Mr Allwood to give verbal cover. I have hesitated much on this branch of the case: but, on the whole, I come to the conclusion that the contention of Mr Bevan for the plaintiff is right. It is, as he has pointed out, a striking feature in this case that there is a substantial body of correspondence between the various officials of the company inter se; and I have read these letters carefully. They contain various questions and comments: but in not one of them is there a suggestion that Mr Allwood acted without authority. That is a most striking circumstance; and I am not sure Mr Bevan is not right in saying it is almost conclusive. But there are other features in this case that lead me to the conclusion that the plaintiff is right. It seems plain from all the witnesses that you cannot carry on a fire insurance business unless you give verbal cover. If this company would not give verbal cover their business would be impossible. They know it and I know it. The broad principle is that an agent cannot work as an agent unless he has authority to give verbal cover. In the present instance Mr Allwood is a most respectable man. He occupies a high position in another company. He is a gentleman of respectability and weight; and there is no reason whatever why he should not be authorised with such power. For two years before this it is plain he had frequently given verbal cover, although it is true cover notes followed: but, as Mr Bevan pointed out, so with regard to Mr Carter and Mr Hammand cover notes followed. I remember the evidence of the various witnesses; and I come to the conclusion, after hearing the arguments, that

Mr Allwood habitually granted verbal cover, and that that practically was and must have been perfectly well known both to Mr Carter and Mr Hammond; and that Mr Allwood was acting with their assent and knowledge. I do not blame them: on the contrary, if they had not given Mr Allwood the right to make verbal cover he could not have got business for the company. The thing that made them give cover was the necessity of the situation. Without doubting the good faith of the witnesses in this case, on the whole, and from the correspondence, I think the recollection of Mr Allwood is more accurate on various points than that of Mr Carter or Mr Hammond. Although, therefore, Mr Allwood was not supplied with a particular book of forms, I am satisfied he was a man to have such verbal authority, and that with the consent of Mr Carter he had it. The result, therefore, is that this transaction on July 16 was within the authority of the agent, and the company would be bound by it.’

(See also, Zurich General Accident Liability Insurance Co Ltd v Rowberry [1954] 2 Lloyd’s Rep 55 (CA)).

3.2.2 Apparent or Ostensible Authority The third party is generally ignorant of the agent’s actual and implied authority and relies on what is termed the agent’s apparent or ostensible authority ie. the agent’s authority as it appears to the world at large. Apparent authority arises where the principal, either by words or, as is more common, by conduct, represents to the third party that the agent has authority to perform a particular act. Where the third party acts on such a representation the principal is

estopped from claiming that the agent acted in excess of his or her actual authority (see the judgment of Diplock LJ in Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480 at 504). An agent’s apparent authority will often coincide with his or her actual authority. ‘But sometimes [apparent] authority exceeds actual authority. For instance, when the board appoint the managing director, they may expressly limit his authority by saying he is not to order goods worth more than £500 without the sanction of the board. In that case his actual authority is subject to the £500 limitation, but his [apparent] authority includes all the usual authority of a managing director…’ Lord Denning MR in Hely-Hutchinson v Brayhead Ltd [1968] 1 QB 549. In Eagle Star Insurance Co Ltd v Spratt [1971] 2 Lloyd’s Rep 116, Lord Denning MR summarised the position regarding the principal’s representation: ‘A principal may hold out an agent as having authority, not only by a representation, but also by his conduct, or even by his silence and acquiescence. Take the owner of a business who puts a manager in charge of the shop or in charge of a farm. He holds out the manager as having authority to make contracts. He may put a private limitation on his authority. He may say he is not to incur liabilities for more than £20. But he cannot rely on that limitation as against the customers. The reason is because he had put the manager in a position to make contracts and is bound by what he does. We had a case a little time ago where a company allowed a “company secretary” to be in the office. Whilst the managing director was away, the company’s secretary

ordered cars on hire in the name of the company without any authority to do so. He ordered them for his own benefit. But the company were held liable. If you find conduct — standing by — of the principal, even though it is not communicated to the other party — and this conduct leads the other party to believe that the agent has authority, that is enough to bind the principal.’

Note: The determination of apparent authority is a fact intensive exercise. For example, in British Bank of the Middle East v Sun Life Assurance Co of Canada (UK) Ltd [1983] 2 Lloyd’s Rep 9, the House of Lords, having scrutinised the particular decision-making structure and processes within Sun Life’s organisation, held that a branch manager of a multinational insurance company lacked apparent authority to represent to the claimant bank that a junior employee had actual authority to execute undertakings on behalf of the company to pay mortgage money to the bank. The weight of evidence pointed to the fact that such undertakings were executed by insurance companies at head office level. [308] Brook v Trafalgar Insurance Co (1946) 79 Ll L Rep 365 (CA) [The issue for the Court of Appeal was whether an agent, Nelson, possessed the requisite authority from the insurers to waive a condition of the policy dealing

with notification of claims. The particular term stated that: ‘Notice of any accident or loss must be given in writing to the company at its head office immediately upon the occurrence of such accident or loss…In the event of failure to comply with the terms of this condition and in particular, if within seven days after such accident or loss has occurred, the company had not been notified as above set forth, then all benefit under this policy shall be forfeited.’ Notwithstanding that waiver had not been expressly pleaded, the trial judge held that the insurers, through their agent, had waived the policy conditions as to notice of loss and that therefore the insured was entitled to recover]. Scott LJ: ‘To put forward a plea of waiver, whether before breach or after breach, of a condition precedent to the right of action contained in a policy is a very serious step. It is quite obvious that it is essential in the interests of justice that the insurance company in such circumstances should have their attention called beforehand to the fact that it is intended to rely on an issue of the kind upon which evidence can be called, and in the absence of an application for leave at the trial to introduce a new issue in that way, I respectfully think that the learned Judge was wrong in considering the issue at all. It would be enough for the purpose of allowing this appeal to say that and nothing more; but I prefer also to deal with the matter as if some form of waiver replication had been before the Court. The learned Judge relied upon the fact that Nelson’s name is mentioned against the printed word “Agent” in the schedule to the policy. He treats that as amounting to conclusive evidence that Nelson had authority on behalf of the company to waive the express condition of written

notice having to be sent to the company’s head office. In my view, even if waiver had been pleaded, that would have been an erroneous inference. It is common knowledge to everybody that policies are issued at the instance of agents who procure the business and who get a small commission on the premium for doing so. That is the sense which prima facie the printed word “Agent” at the bottom of a policy bears; it appears there for the simple reason that it so serves as a record for the office files of the company as to who was the person entitled to commission. To suggest that the word “Agent” in front of the name there gives the commission agent authority to take the place of the company and waive an express condition requiring that written notice should be sent to the head office of the company, when they have dozens of agents all over the country of that type, is, I venture to think, ridiculous…’

Tucker LJ: ‘The first thing that would have had to be alleged was that Nelson was the agent of the insurance company, and it would have been necessary to show whether he was an agent with authority to waive the conditions of the policy pursuant to some express authority derived from the company, or whether he was an ostensible agent held out with such authority, and in the latter event it would have been necessary to give particulars showing the facts and matters relied upon in support of the allegation that he had been held out as having such authority. That was not done. If it had been done, no doubt there would have been discovery showing the position and relationship of Mr Nelson to the insurance company, and all relevant documents of that kind would have been disclosed. All those matters are matters which it is very necessary when a plea of this kind is raised should be carefully considered in the light of all the available evidence.

In this case there was no such plea and, therefore, it is not surprising that the evidence with regard to these matters was of a very scanty and sketchy nature. First of all, in my view, there was no evidence at all that Mr Nelson was an agent having authority to waive the written conditions of the policy. The only evidence that he was an agent at all was contained in the schedule to the policy where he is put in as “Agent: J Nelson.” That clearly indicates he was an agent of some kind, but, especially in connection with insurance matters, there are all kinds and various degrees of agency. The mere fact that a man is described in a policy as an agent is not in itself sufficient to show that he has authority conferred upon him to waive the express conditions of the policy, one of which incidentally it is to be observed, viz, No 9, provides that “Any alteration in the terms of this policy is only binding upon the company when made at the head office under the hand of a managing director or secretary.” The only other matter which is relevant to the question of Mr Nelson’s agency is the answer given by the plaintiff himself, where he was asked the very leading question: “Is he an agent of this company?” — that is referring to Mr Nelson — to which he gave the answer: “Yes.” With regard to that it was not only a leading question, but it was a question with regard to which Mr Brook clearly was not in a position to give any answer of any value at all. So much for Mr Nelson’s agency. The matter does not stop there, because, assuming that he was an agent with this authority, I am quite unable to find from the evidence that was given, any evidence of conduct on his part which would have amounted to waiver had he had that requisite authority…’

(See also, Berryere v Fireman’s Fund Insurance Co (1965) 51 DLR (2d) 603; and Stone v Reliance Mutual

Insurance Society Ltd (below, [314])).

3.2.3 Ratification Notwithstanding that an act of an agent is in excess of his or her actual or apparent authority, the principal will be bound where it has ratified the agent’s conduct. For ratification to be effective the agent must have purported to act on behalf of the principal; and the principal must be capable of being ascertained: Eastern Construction Co Ltd v National Trust Co Ltd and Schmidt [1914] AC 197 at 213. Ratification operates retroactively to the time when the unauthorised act took place. In marine insurance ratification after the occurrence of a loss is possible and in National Oil Well v Davy Offshore Ltd [1993] 2 Lloyd’s Rep 582, Colman J expressed the view that this should also be the position in non-marine insurance.

3.3 Identifying an Intermediary’s Principal Identifying an agent’s principal assumes particular importance in relation to two critical issues: (i) the imputation of knowledge possessed by an agent (for example, if a material fact is disclosed by an insured to the agent, and the agent does not pass this information to the insurer, the insurer will not be able to avoid the policy for non-disclosure if it is found to

be the agent’s principal); and (ii) determining to whom the agent’s duties are owed. Broadly speaking it can be said that insurance agents and Lloyd’s brokers are presumed to be the agents of the insured (on the position of Lloyd’s brokers see Lord Diplock’s speech delivered in American Airlines Inc v Hope [1974] 2 Lloyd’s Rep 301). That this may run contrary to the perception of the typical applicant for insurance was recognised by both the trial judge and Purchas LJ in Roberts v Plaisted [1989] 2 Lloyd’s Rep 341: ‘Under the present state of insurance law [the broker] acted for the assured as his agent and even if the latter disclosed to the former all material facts, if the broker then omitted to include these upon the form there is no protection afforded to the assured in his claim against insurers. On this aspect of the cases Hodgson J commented: “Before I come to examine this contract it is clear that, if the insurers’ contention is correct, this Plaintiff is yet another victim of the insurance industry. He made the fullest disclosure to the broker; like the majority of laymen he probably thought that that was enough and that the broker was the agent of the insurers by whom he was remunerated by way of commission; that mistake was one which, unhappily, is all too common, and all too often used by insurers to escape liability.” Full and frank disclosure to the Lloyd’s broker concerned in presenting on behalf of the proposed assured the proposal to the insurers as against an insurer who complains of nondisclosure and repudiates on that ground avails the proposed insured in no sense at all. To the person unacquainted with the insurance industry it may seem a

remarkable state of the law that someone who describes himself as a Lloyd’s broker who is remunerated by the insurance industry and who presents proposals forms and suggested policies on their behalf should not be the safe recipient of full disclosure; but that is undoubtedly the position in law as it stands at the moment. If I may say so, Mr Justice Hodgson’s strictures on this matter are more than justified. Perhaps it is a matter which might attract the attention at an appropriate moment of the Law Commission.’

Salaried representatives of insurance companies, on the other hand, are deemed to be the agents of the insurer even where part of their remuneration is made up of commission. That said, and as the cases reveal, there are exceptions to these broad propositions. As seen in Stockton v Mason and the Vehicle and General Insurance Co Ltd (above, [306]), the implied authority of the broker to issue cover notes was clearly material to the court’s finding that he was the insurer’s agent in this regard.

3.3.1 Imputing an Agent’s Knowledge to the Insurer As indicated above, typically an insured will seek to show that the insurer has constructive knowledge of a non-disclosed fact by virtue of the broker in question being in possession of the information in question. Whether or not such knowledge will be imputed to the principal will depend upon the agent’s actual or apparent authority.

[309] Wing v Harvey (1854) 5 De GM & G 265 [A life policy contained a condition which provided that if the insured ‘shall go beyond the limits of Europe without the licence of the directors, [the] policy shall become void.’ An assignee of the policy, upon paying the premium to a local agent of the insurers at the branch office where the insurance had first been effected, informed him that the insured was living in Canada. The agent, Mr Lockwood, advised the assignee that the policy would be valid provided the premiums were regularly paid. When the insured, Mr Bennett, died the insurers declined payment on the basis of breach of condition]. Turner LJ: ‘In this case Mr Lockwood, and afterwards his successor Mr Thompson, were beyond all doubt the agents of the insurance office to receive the premiums payable upon the policies, and they successively did receive those premiums upon the policies during the whole period from 1835, when Mr Bennett went to Canada, to 1849, when he died. The premiums were received with a knowledge, on the part of Mr Lockwood and Mr Thompson, that the payments were made by Mr Wing upon the faith of the policies being subsisting policies and valid, notwithstanding the absence of Mr Bennett beyond the limits of Europe, and the society or their officers received those premiums without objection. It has been said, however, that the office so received them without having notice of Mr Bennett’s residence beyond the prescribed limits. Now if it was material to decide that question of fact, I should hold, upon the affidavits before us, that the office was affected with notice of the absence of Mr Bennett beyond the boundaries limited by he policies. I

think it, however, immaterial to determine that question. The office undoubtedly received the money from their agents to whom it had been paid upon express terms and conditions, and the office, having held out Mr Lockwood and Mr Thompson to the world as their agents for the purpose of receiving the premiums, I think it became the duty of of Mr Lockwood and Mr Thompson, and not that of the Plaintiff, to communicate to the head office at Norwich the circumstances under which those premiums had been paid to and received by them, and the representations which were made on the occasions of such payments and receipts. Upon these grounds my opinion is, that these policies must be considered to have been continuing policies, and that this claim must therefore be allowed.’

[310] Blackley v National Mutual Life Association of Australia [1972] NZLR 1038 (CA) [The insured, who had a history of treatment for various cancers, applied for a life policy through K, the respondent company’s agent. Prior to the policy being issued, the insured underwent an operation to have a malignant brain tumour removed. K was aware of this having been told when he called on the insured’s wife to collect the first premium which she paid by cheque. The insured was too ill to sign a banker’s order left by K in respect of future premiums and so his wife duly executed it and mailed it back to the insurers. When the insurer’s medical examiner learned of the operation he notified the branch manager and the insurers repudiated liability on the basis of non-disclosure. The company returned the

first premium together with the banker’s order. No policy was issued. Shortly after, the insured died. His widow argued that a contract had been concluded when she had returned the banker’s order. The insurers contended that K lacked authority to receive disclosures on their behalf and so they were not fixed with knowledge of the insured’s operation. It was held by the New Zealand Court of Appeal that K had ostensible authority to receive such information and therefore the insurers had constructive knowledge of the non-disclosed facts]. Turner P: ‘[I]t is interesting to recall the following cross-examination of Mr Law on the question of Mr Kitt’s ostensible authority to receive disclosures: “It is part of Mr Kitt’s ostensible authority to receive the first premium on behalf of the Association? Yes Is it part of his duty to tell the Association of any knowledge he may receive about the nature of the risk? Yes So was it part of his duty to inform the Association or see that it knew if he heard Dr Blackley had been taken ill? Yes. And lie would be the person you would expect to be told by a proponent if there was some alteration? Normally the agent would be told. And it would then be up to the agent to pass it on? Yes.” I have no doubt that Mr Kitt was held out to the Blackleys as an agent to whom disclosures might properly be made. What was urged upon Richmond J, and upon us, for the defence, and what Richmond J held, was not that he was not so held out, but that even though he was so held out, the disclosure to him by Mrs Blackley should in the

circumstances of the particular case not be regarded as disclosure to the Association. The imputation to a principal of the knowledge of an agent when that agent knowledge has been disclosed to him in reliance upon his ostensible authority to receive it is an application of the principles of estoppel. Though the agent may not in fact have the principal’s authority to receive the disclosure so as to bind the principal as if the latter had knowledge of it, yet the principal may not aver that he was not notified of the facts disclosed, for by holding out the agent he must be deemed, as against the third party, to have given the authority which in fact the contract of agency may not have conferred. But it is always an answer to a plea of estoppel that the representee in fact knew the true position, or did not believe the representation, and that therefore he did not do what he did in reliance upon the representations of the party sought to be estopped. So in the law of agency when it is pleaded that a principal has held out an agent as one clothed with authority to receive disclosures, as if made to the principal, it will be an answer that the third party knew or believed that the disclosures had not in fact been or would not in fact be passed on to the principal. This is the basis of the “exception” of which Bowstead speaks in the passage which I have already cited. But Richmond J applied this to the case in which the third party, not well knowing that the information would not be passed on, merely thought this a likely possibility or, more accurately, should be assumed so to have thought; and he held that the Doctor and Mrs Blackley, if they had thought about the matter, would have realised that it was likely that Mr Kitt had not passed on and would not pass on the information which he had gained to the Association. I think that he was wrong in two respects. First. it was not enough that Mrs Blackley, if she had thought about the matter, would as a reasonable person have thought it likely that Mr Kitt had not passed on, and would not pass on, the

information. Secondly, I do not think that the evidence could warrant even the conclusion that she should have thought that this was likely. I will deal with these two points in order. First, I think that to answer the contention that the disclosure here was sufficient, since it was made to an agent clothed with ostensible authority to receive it, it would be necessary not only to show that the Blackleys suspected, or should have suspected, that the disclosure would not be passed on by Mr Kitt to those superior to him; it must be necessary in my opinion to show that the Blackleys actually knew or believed that the information had not been, and, or would not as the case may be relayed. This is the way in which the rule is stated in Bowstead; and the cases cited in that work appear to me to support, this view… I am of the opinion…that once it is held, as I am prepared to hold, that in this case Mr Kitt was the agent of’ the Association clothed with ostensible authority to receive any disclosures which Dr Blackley offered to make in discharge of his obligation under the condition in the proposal, due disclosure to him was disclosure to the Association, and that this result is not affected, either by the fact that in the event he did not pass the information on, or by any suspicion or possibility, short of actual knowledge or positive belief, by Mrs Blackley, that he had not and would not pass the information on to the Association… In the case before us there is no suggestion that the proposal was inaccurately or inadequately filled in. What is said is simply that after the proposal had been correctly filled in as the parties then understood the facts, supervening events occurred of which it was the duty of the proponent to make disclosure to the Association. The only question is, whether by communicating information of these events, when they became known, to the Association’s agent, the proponent and his wife made due disclosure. I find many of the cases cited of little help on this. In Ayrey v British Legal Assurance Co [1918] 1 KB 136, however, one of

the cases cited on both sides, there is a passage which has seemed to me of assistance. That was a case admittedly stronger for the plaintiff than the one before us, since the person to whom notice was given was the district manager of the company, and not a mere agent. But Atkin J said at p 142: “I have great difficulty in seeing how an assured who desired to impart information to the company could reasonably be supposed to do so otherwise than by giving the information to the district manager. He is the person who is named on the premium card as the district manager of the company, and in my opinion it must be implied that the person holding that position is the person who has authority to receive on behalf of the company information as to all matters affecting a policy issued by the company, and that it was his duty to pass on to the company such information as lie might receive. I think, therefore, that the knowledge of the district manager that there had been a breach of a condition by reason of the concealment of a material fact was the knowledge of the company.” Of course, there it was the district manager of whom Atkin J was speaking. That, was a stronger case. But here, once it has been held that Mr Kitt was held out by the company as its agent to whom disclosures might properly be made, the difference becomes one of degree only. The fact of such an ostensible agency concludes the matter as governed by the same principle as Atkin J adopted. For the reasons which I have already given I have found it proved that the ostensible authority of Mr Kitt included authority to receive oral disclosures. Once that is proved, in my opinion the case for the defence fails.’

(See also, Woolcott v Excess Insurance Co Ltd [1979] 1 Lloyd’s Rep 231).

Notes: 1. The issue of imputation of knowledge commonly arises in the situation where the agent completes the proposal form for the prospective insured. If in answer to a question contained in the form the insured tells the truth but the agent falsify’s the answer, the question arises whether the proposer is bound by the agent’s conduct. The solution will depend upon who is the principal. If it is the proposer, then he or she is bound and the insurers will not be deemed to have constructive knowledge of the truth. If, however, the agent is a full-time employee of the insurer it might be tenable to argue on the basis of Wing v Harvey (above, [309]) and Blackley (above, [310]), that knowledge of the truth should be imputed to it as principal. 2. The knowledge of an agent who is acting to defraud his or her principal cannot be imputed: Group Josi Re v Walbrook Insurance Co Ltd [1996] 1 Lloyd’s Rep 345. [311] Bawden v London, Edinburgh & Glasgow Assurance Co [1892] 2 QB 534 (CA) [The insurer’s agent completed a proposal form for accidental injury insurance on behalf of a proposer who was illiterate and had lost an eye. The agent was

aware of the proposer’s condition but did not communicate this to the insurers. The form contained a term warranting that the insured was free from physical infirmity. The insured was involved in an accident and lost his good eye. The insurers repudiated liability]. Lord Esher MR: ‘We have to apply the general law of principal and agent to the particular facts of this case. The question is, what was the authority of such an agent as Quin? His authority is to be gathered from what he did. He was an agent of the company. He was not like a man who goes to a company and says, I have obtained a proposal for an insurance; will you pay me commission for it? He was the agent of the company before he addressed Bawden. For what purpose was he agent? To negotiate the terms of a proposal for an insurance, and to induce the person who wished to insure to make the proposal. The agent could not make a contract of insurance. He was the agent of the company to obtain a proposal which the company would accept. He was not merely their agent to take the piece of paper containing the proposal to the company. The company could not alter the proposal; they must accept it or decline it. Quin, then, having authority to negotiate and settle the terms of a proposal, what happened? He went to a man who had only one eye, and persuaded him to make a proposal to the company, which the company might then either accept or reject. He negotiated and settled the terms of the proposal. He saw that the man had only one eye. The proposal must be construed as having been negotiated and settled by the agent with a one-eyed man. In that sense the knowledge of the agent was the knowledge of the company. The policy was upon a printed form which contained general words applicable to more than one state of circumstances, and we

have to apply those words to the particular circumstances of this case. When the policy says that permanent total disablement means “the complete and irrecoverable loss of sight in both eyes,” it must mean that the assured is to lose the sight of both eyes by an accident after the policy has been granted. The contract was entered into with a oneeyed man, and in such a case the words must mean that he is to be rendered totally blind by the accident. That, indeed, would be the meaning in the case of a man who had two eyes. If the accident renders the man totally blind, he is to be paid £500 for permanent total disablement. Quin, being the agent of the company to negotiate and settle the terms of the proposal, did so with a one-eyed man. The company accepted the proposal, knowing through their agent that it was made by a one-eyed man, and they issued to him a policy which is binding upon them, as made with a one-eyed man, that they would pay him £500 if he by accident totally lost his sight, ie, the sight of the only eye he had. In my opinion, the plaintiff is entitled to recover £500 for the total loss of sight by the assured as the direct effect of the accident.’

Lindley LJ: ‘I am of the same opinion. The case turns mainly upon the position of Quin. What do we know about him? The company have given us no information about the terms of his agency. In the printed form of proposal he is described as the agent of the company for Whitehaven, and it is admitted that he was their agent for the purpose of obtaining proposals. What does that mean? It implies that he sees the person who makes the proposal. He was the person deputed by the company to receive the proposal, and to put it into shape. He obtains a proposal from a man who is obviously blind in one eye, and Quin sees this. This man cannot read or write, except that he can sign his name, and Quin knows this. Are we to be told that Quin’s knowledge is not the knowledge of

the company? Are they to be allowed to throw over Quin? In my opinion, the company are bound by Quin’s knowledge, and they are really attempting to throw upon the assured the consequences of Quin’s breach of duty to them in not telling them that the assured had only one eye. The policy must, in my opinion, be treated as if it contained a recital that the assured was a one-eyed man. The £500 is to be payable in case of the “complete and irrecoverable loss of sight in both eyes” by the assured. If the assured has only one eye to be injured, this must mean the total loss of sight. Within the true meaning of the policy, as applicable to a one-eyed man, I think the plaintiff is entitled to recover £500.’

Notes: The decision in Bawden cannot be taken to represent the general rule and has been distinguished in a number of cases. On its particular facts, the decision might be explained by reference to the plea of non est factum (see further, J. Beatson, Anson’s Law of Contract (Oxford, OUP, 2002) at 332 et seq). [312] Biggar v Rock Life Assurance Co [1902] 1 KB 516 [The facts appear from the judgment]. Wright J: ‘In this case Biggar, who was a publican, seems to have been canvassed by the insurance company’s agents, who in February induced him to send in a proposal for insurance against accidents. The ordinary course would have been for the applicant to fill in the answers to the questions in the proposal form; but in the present case Cooper, the

company’s agent, filled up the proposal form without consulting Biggar as to the answers to be given, and then invited Biggar to sign the form so filled up, which Biggar did without reading it. The proposal form so signed contained not only the questions, with the answers inserted by the agent, but also a declaration at the foot to which Biggar himself signed his name, and which stated (inter alia) that “no company has ever declined to assure me nor to renew my policy,” and also that he requested the company to grant “a policy in accordance with the above particulars”; by the declaration Biggar further agreed that “the above statements shall form the basis of the contract.” The answers inserted by Cooper, the agent, were false in many material particulars; but Biggar was not aware of their falsity, and apparently was not aware of what the answers were in fact or of what were the questions to which they were the answers. This false proposal form was afterwards transmitted to the company by Cooper and the proposal was accepted; the premium was then paid by Biggar through Cooper and the policy was issued. Some little time afterwards Biggar met with an accident, and the question now is whether he is entitled to recover on the policy. It is plain that the policy is prima facie avoided, for some of the particulars and statements in the answers, the correctness of which was a condition precedent to the validity of the policy, were false; Biggar, therefore, cannot recover unless he is able to shew that the insurance company is prevented from setting up that ground of avoidance by reason of its agent, Cooper, having acted in fraud of his principals. I will deal with a minor point first. It is said that in any case (whatever may be the proper decision as to the main question here) the claimant is disentitled to recover, because he signed a paper containing certain other particulars, and especially the statement that no company had ever declined to assure him or to renew his policy. I am inclined to think that that is of itself sufficient to prevent him

from having any claim against the company; but I do not wish to rest my decision upon that, because I do not think the case was stated with reference to that particular contention, and I do not think it is so explicit with regard to it as I could have wished. I do not feel quite clear that this representation which he signed is sufficiently untrue, and I prefer to deal with the case upon the main point. As to that, I agree with the principles which were laid down by the Supreme Court of the United States in New York Life Insurance Co v Fletcher 117 U S 519, decided in 1885, in which the judgment of the whole Court was delivered by Field J. It seems to me that that case is very much in point, although in some respects it is different from the present case: in some respects it is weaker, and in some respects stronger. I agree with the view taken by the Supreme Court in that case, and apparently in other cases there cited, that if a person in the position of the claimant chooses to sign without reading it a proposal form which somebody else filled in, and if he acquiesces in that being sent in as signed by him without taking the trouble to read it, he must be treated as having adopted it. Business could not be carried on if that were not the law. On that ground I think the claimant is in a great difficulty. But, further, it seems to me that here, as in the case of New York Life Insurance Co v Fletcher, it would be wrong to treat Cooper, the company’s agent, as their agent to suggest the answers which Biggar was to give to the questions in the proposal. Cooper was an agent to receive proposals for the company. He may have been an agent, as Lindley and Kay LJJ put it in Bawden v London, Edinburgh and Glasgow Assurance Co [above, [311]] to put the answers in form; but I cannot imagine that the agent of the insurance company can be treated as their agent to invent the answers to the questions in the proposal form. For that purpose, it seems to me, if he is allowed by the proposer to invent the answers and to send them in as the answers of the proposer, that

the agent is the agent, not of the insurance company, but of the proposer. I cannot put the doctrine better than in the language of the Supreme Court in New York Life Insurance Co v Fletcher, at pp 532–33 of the case referred to, where they are citing from and adopting previous decisions of the Supreme Court. They say (speaking of another case): “The application was signed without being read. It was held that the company was not bound by the policy; that the power of the agent would not be extended to an act done by him in fraud of the company and for the benefit of the insured, especially where it was in the power of the assured by reasonable diligence to defeat the fraudulent intent; that the signing of the application without reading it or hearing it read was inexcusable negligence; and that a party is bound to know what he signs.” Then, speaking of the agent’s conduct, they say: “His conduct in this case was a gross violation of duty, in fraud of his principal, and in the interest of the other party. To hold the principal responsible for his acts, and assist in the consummation of the fraud, would be monstrous injustice. When an agent is apparently acting for his principal, but is really acting for himself or third persons and against his principal, there is no agency in respect to that transaction, at least as between the agent himself, or the person for whom he is really acting, and the principal…The fraud could not be perpetrated by the agent alone. The aid of the plaintiff or the insured, either as an accomplice or as an instrument, was essential.” Then they go on:

“She says that she and her husband signed the application without reading it and without its being read to them. That of itself was inexcusable negligence. The application contained her agreements and representations in an important contract. When she signed it she was bound to know what she signed. The law requires that the insured shall not only in good faith answer all the interrogatories correctly, but shall use reasonable diligence to see that the answers are correctly written. It is for his interest to do so, and the insurer has a right to presume that he will do it. He has it in his power to prevent this species of fraud, and the insurer has not.” That doctrine of the Supreme Court of the United States seems to me to be good sense and good law. Even if those doctrines are not to be applied to their full extent, still I cannot conceive how this policy can be held to be binding on the company. The very basis of the policy is the statements in the proposal. These statements are false in several material respects. How, then, can the policy be binding on the company? If the plaintiff is entitled to anything, I think that the most he could ask for would be that the Court should say that the contract is void on the ground of either fraud or mistake, with the consequence, perhaps, that he may be entitled to recover back the premium that he paid; but I cannot see how it can be held under these circumstances that the company is bound by the policy. I see no equity against the company in this case — no equity, for instance, such as might exist on the ground of receipt of premium with knowledge of the falsity of the statements. They never knew of the falsity of the statements, and they never knew that the proposal form had been filled in with answers invented by the person purporting to act as their agent. I think the answer to the

question asked by the learned arbitrator must be that the facts stated shew a defence in law.’

[313] Newsholme Bros v Road Transport and General Insurance Co Ltd [1929] 2 KB 356 (CA) [The insurers agent who, although told the true facts, inserted false answers when completing a proposal form for the insurance of a bus. The form, which was signed by the insured, contained a basis of the contract clause. The agent was not authorised by the insurance company to complete proposal forms. His duties were to sell insurances and to check that proposal forms were duly completed. He was not authorised to give a cover note or to conclude contracts of insurance. A policy was issued. When the insured made a claim under it, the insurers repudiated liability on the ground of the untrue statements in the proposal form]. Scrutton LJ: ‘In my view, the important question for the decision of this case is whether the knowledge of the agent, acquired in filling up the proposal for the assured, is to be taken as the knowledge of the company. If the person having authority to bind the company by making a contract in fact knows of the untruth of the statements and yet takes the premium, the question may be different. Even then I see great difficulty in avoiding the effect of the writing signed by the proposer that the truth of the statements is the basis of the contract. But where the person contracting for the company has no actual knowledge, but only constructive notice, the

difficulties of the proposer are greater. In commercial matters, the doctrine of constructive notice is not favoured…In Blackburn, Low & Co v Vigors (1887) 12 App Cas 531 a broker employed to effect an insurance, heard of a fact affecting the risk, and did not tell his principal. That broker did not effect that insurance, but, later, the principal did effect an insurance on that risk. On a loss occurring, the underwriters alleged that the knowledge of the first broker was the knowledge of the principal, and as the principal had not disclosed a fact he must be taken to have known, the insurance was void. The House of Lords held that this contention was erroneous; that while it was true that if the first broker had effected a policy, he would have been bound to disclose his actual knowledge to the underwriters, he was not so bound to disclose his knowledge to his principal that his principal, though it was not disclosed, must be taken to know it. Another objection to this imputation of constructive knowledge may be found in the recent decision of the House of Lords, in Houghton’s case [Houghton v Northard, Lowe [1928] AC 1, 18, 19], where Lord Sumner points out that where knowledge is to be imputed to an artificial person, in the first place it must be the knowledge of the directors who deal with the company’s rights, and, in the second place, the knowledge of a person who acquires it in a breach of duty, and is guilty of a breach of duty in respect to it, is not to be imputed to a company to whom, from the hypothesis, he would be very unlikely to disclose it in fact. He cites In re Hampshire Land Co. [1896] 2 Ch. 743, 750, where Vaughan Williams LJ declines to hold that the agent’s “knowledge of his own fraud or of his own breach of duty is, under the circumstances, the knowledge of the company.” I find it difficult to reconcile these principles laid down in the highest tribunal with the decision in Bawden’s case [see above, [311]]…It appears to me that the facts in this present case are not substantially similar with those in Bawden’s case so as to make the conclusions of law drawn from them in the

latter case binding on this Court, even if those conclusions are not inconsistent with the two decisions in the House of Lords to which I have referred. In my view the decision in Bawden’s case is not applicable to a case where the agent himself, at the request of the proposer, fills up the answers in purported conformity with information supplied by the proposer. If the answers are untrue and he knows it, he is committing a fraud which prevents his knowledge being the knowledge of the insurance company. If the answers are untrue, but he does not know it, I do not understand how he has any knowledge which can be imputed to the insurance company. In any case, I have great difficulty in understanding how a man who has signed, without reading it, a document which he knows to be a proposal for insurance, and which contains statements in fact untrue, and a promise that they are true, and the basis of the contract, can escape from the consequences of his negligence by saying that the person he asked to fill it up for him is the agent of the person to whom the proposal is addressed.’

Notes: While the decision in Newsholme continues to represent the orthodoxy in English insurance law, it was distinguished by the Court of Appeal in Stone (below, [314]) and has not been followed in other common law jurisdictions (see the decision of the Supreme Court of Canada in Blanchette (below, [315]) and the statutory reforms in Australia and New Zealand (see below, ‘Reform’ and [324]). In distinguishing Newsholme, Lord Denning MR placed considerable emphasis upon the authority of the particular agent in Stone and the fact that the

insurers had in their possession the means to ascertain the truth with respect to the earlier lapsed policy (see also, Ayrey v British Legal and United Provident Assurance Co Ltd [1918] 1 KB 136 — information given to a district manager was imputed to head office). [314] Stone v Reliance Mutual Insurance Society Ltd [1972] 1 Lloyd’s Rep 469 (CA) [The facts appear from the judgment]. Lord Denning MR: ‘Mr. Leonard Stone lives with his wife in a flat at 86 Hebden Court, Laburnum Street, [E.2] He took out policies of assurance in respect of fire, theft and endowments with the Reliance Mutual Insurance Society Ltd. The premiums were payable weekly. They were collected by collectors who called at the door and entered the amount in a premium receipt book for each policy. One of these policies covered the risk of fire. This was issued as a result of a call by a canvasser, Mr Brooks, on 26 April, 1966. He saw the wife, Mrs. Stone. He filled in the proposal form and she signed it. In February, 1967, there was a fire at the premises. The branch manager went to see the damage. The society paid Mr Stone £280 3s. 6d. for the damage done. In August 1967, the policies lapsed because the premiums had not been paid. It is not suggested that this was the fault of Mr or Mrs Stone. She said that the collector had not been to collect the money. In January 1968, Mr O’Shea, an inspector, called from the insurance society. He had with him a new agent to show him the area. He was calling on people who were existing

policyholders or whose policies had lapsed and to seek their revival. He was not canvassing for new business. Mr Stone was not in. So Mrs Stone saw Mr O’Shea. He asked her if she would like to take out a new policy, and suggested it should be for a higher amount, £1,100, instead of £500. She said in evidence: “I agreed, and he got out some forms and started filling them in. He didn’t ask me any questions. When he’d filled them in (2 forms) he gave them to me to sign. He showed me where to sign. I didn’t read them.” Mr O’Shea agreed that he filled in the forms. He said in evidence: “It is company policy that I should put the questions, writing down answers.” As much turns on the proposal form, I must read a good deal of it. It was a printed form…. “5. State Policy Numbers of insurance held by you with the Society and whether lapsed or in force. None … 7. Give particulars and dates of any claims you have made in respect of any risks hereby proposed to be insured None …………………………………………………………… 1. State sum proposed to be insured: [for fire or burglary] £1100 I HEREBY DECLARE that the answers given in the above proposal are in every respect true and correct…and that I have not concealed any important circumstances that ought to be communicated to the Society. I further declare in so far as any part of this proposal is not written by me the person who has written same has done so by my instructions and as my agent for that purpose. I

agree that the above proposal and this declaration shall be the basis of the Contract of Insurance between the Society and myself, and I am willing to accept a policy subject to the provisions and conditions contained therein, and I agree that the liability of the Society does not commence until this proposal has been accepted by the Directors and the premium paid. Proposer’s Signature X Theresa Stone Witness S.O’Shea Date 29/1/68.” There is a mark near Mrs Stone’s signature as if she was told where to sign. It is apparent that the answers to questions 5 and 7 were wrong. Mr O’Shea must have made a mistake in filling them in. The society had information, no doubt in their own records about the lapsed policies and about the fire claim. Mr O’Shea cannot have known about them or remembered them - else he could not have inserted “None” as the answers. The proposal form went up to the head office of the society. They do not seem to have checked their records either. At any rate they issued a policy against burglary and housebreaking and it was delivered to 86 Hebden Court, E.2. It gave the insured as Leonard Stone. The commencement date was 29 January 1968. The sum insured was £1,100. The premium was 10d. a week. Thereafter the premiums were duly paid. On 16 October 1969, thieves broke into Mr Stone’s flat at 86 Hebden Court. He at once called the police. He obtained a claim form from the local office. Within two days, on 18 October 1969, he put in his claim to the Reliance Insurance Society. On the form was a question to which he gave answers disclosing fully the previous fire claim; thus showing good faith.

“11. Have you ever before sustained loss by fire, burglary, YES housebreaking or larceny?……………FIRE DAMAGE FEB-1966 Was a claim made upon any Company or underwriters? If PAID £280 so, give name, date, nature of loss and amount paid…” That answer was quite correct except that “1966” was a mistake for “1967”. He added a list of the items stolen amounting to £211. Mr Stone sent that form in to the local office of the Reliance Insurance Society in Leyton. They received it on 23 October, 1969. An assessor went to the flat and agreed the amount at £211. The collectors went on collecting the premiums which were duly paid. On 9 January 1970, he signed another claim form containing the same particulars, and sent it to the local office at Leyton. They sent it on to the head office at Tunbridge Wells. Head office received it on 19 January 1970, and rejected the claim. They alleged that he had not disclosed the previous fire claim… The case was tried in the Mayor’s and City of London Court. The Judge reserved his judgment and, with some regret, dismissed the claim. He thought that the case could not be excepted from the established principle as set out in Newsholme Bros v Road Transport and General Insurance Co Ltd [above, [313]]. His findings are not quite as full as one could have wished. But, as I read them, this much is quite clear. Neither party was guilty of any fraud. Fraud was not alleged. It was not proved. It was not found. The only inference is that the answers in the proposal form were inserted by mistake. Whose mistake? Clearly Mr O’Shea’s mistake: because he did not ask Mrs Stone the questions; and he inserted the answers out of his own head, without checking up from her — or from the Society’s records — whether they were true or not. No doubt it was Mrs Stone’s

mistake too. She ought to have read through the questions and answers before she signed the form: but she did not do so. Her mistake was, however, excusable, because she was of little education, and assumed that the agent would know all about the previous policies and that there had been claims made under them. She said: “He didn’t ask about any previous claims. He already knew about it.” On those facts, it seems to me that the agent by his conduct impliedly represented that he had filled in the form correctly and that he needed no further information from her. Relying on this implied representation, she signed the form which he put before her. Later the policy was sent and she paid the premiums. What then is the legal position? It is quite clear that, in filling in the form, the agent here was acting within the scope of his authority. He said: “It is company policy that I should put the questions, writing down answers.” This distinguishes the present case from Newsholme’s case, where the agent had no authority to fill in the proposal forms: and it was held that he was merely the amanuensis of the proposer. The present case is more like Bawden v London, Edinburgh and Glasgow Assurance Co [above, [311]]…That case was adversely commented on in Newsholme’s case, but I think it was correctly decided. It would have been most unjust if the company had been allowed to repudiate liability. The case presents itself to my mind like this: The society seek to repudiate liability by reason of the untruth of two answers in the proposal form. They seek to fasten those untruths onto the insured. They do so by virtue of a printed clause in the proposal form. They make out that it was the insured who misled them. Whereas the boot is on the other leg. The untrue answers were written down by their own agent. It was their own agent who made the mistake. It was he who ought to have known better. It was he who put the printed form before the wife for signature. It was he who

thereby represented to her that the form was correctly filled in and that she could safely sign it. She signed it trusting to him. This means that she, too, was under a mistake, because she thought it was correctly filled in. But it was a mistake induced by the misrepresentation of the agent, and not by any fault of hers. Neither she nor her husband should suffer for it. No doubt it was an innocent misrepresentation for which in former times the only remedy would be to cancel the contract and get back the premiums. But nowadays an innocent misrepresentation may give rise to further or other relief. It may debar a person from relying on an exception. Likewise in this case it disentitles the insurance company from relying on the printed clause to exclude their liability. Their agent represented that he had filled in the form correctly: and having done so, they cannot rely on the printed clause to say that it was not correctly filled in. So they are liable on the policy.’

[315] Blanchette v CIS Ltd (1973) 36 DLR (3d) 561 (Supreme Court of Canada) [The insured had signed a composite proposal form for insurance covering his granary and public liability. He subsequently telephoned the insurers representative, Raiche, to obtain cover on his tractor. Raiche, who completed the relevant part of the previously signed proposal form, entered incorrect answers to the questions contained therein. The proposal form contained a basis of the contract clause. The issue for the Court was whether the insured was Raiche’s principal and therefore bound by his misrepresentations thus entitling the insurers to repudiate liability].

Pigeon J: ‘Raiche was not a mere soliciting agent, that is a man having no authority to make a contract binding the company. In order to hold that no contract results from the receipt of the premium with an application under such circumstances, one would have to say that this is an offer open to acceptance for an indefinite length of time that is, as long as the company does not decide whether to accept or to refuse the offer. This would mean that if a loss occurs in the meantime, which may be a matter of weeks if not months, it could simply refuse the offer, but otherwise it could issue a policy dated from the day specified in the application, thus taking the benefit of the premium for the elapsed time without having been at risk. This cannot be so. If the company is to earn the premium from the date of the application by issuing a policy bearing that date, this means that a contract has been made when the premium was received by the agent. On the basis that initially the application covered only the granary and the liability, appellant testified that there had been. no questions put with respect to the Farm Equipment Floater and no answers given or written. He asked the agent to come back in order to cover the tractors but Raiche said this was unnecessary and it could be done by telephone conversation. Appellant admits that Raiche did not at that time repeat the statement that he would be covered immediately. In my view, this makes, no difference. The previous statement was clearly the enunciation of an established policy, as a matter of fact, the agent’s interpretation of the company’s established policy. It should therefore be understood to apply to the tractors as well as to the other risks. This is borne out by the letter written by the company to appellant’s solicitors in which there is this statement:

“Your letter deals with Mr Blanchette’s application for insurance through Mr Raiche and the fact that Mr Raiche advised Mr Blanchette that his equipment was covered by fire insurance, until our Company rejected the. application. While this commitment on the part of our Agent may be correct, we have refused to accept the application, on the basis of misrepresentation and non-disclosure on the part of Mr Blanchette.” In view of the evidence as to Raiche’s duties, I fail to see how it can be said that he did not have at least apparent authority to make this commitment. He was not a mere soliciting agent, he had some authority to bind the company and the latter should be held to whatever authority he professed to exercise and was reasonably believed to have… Under these circumstances, can the company rely on the inaccurate answer written by the agent? We are not here dealing with an application signed in blank which the insured has authorised the agent to fill subsequently. We are faced with what is really a second contract made by telephone between the agent and the insured. I cannot agree that an applicant for insurance who signs an application form leaving a part concerning “farm equipment” completely blank and who later applies for this type of coverage and authorizes by ‘telephone the company’s agent to complete the form for that coverage, must be in the same position at law as if he had signed the form without reading answers previously entered by the agent. I can see no authority for that proposition and there is undoubtedly an important difference between the two situations. When the insured signs after the answers have been entered by the agent, he has the opportunity of reading them. On the assumption that he is under a duty to verify before signing that the agent has properly filled in the

form, I can understand how he can be said to be negligent if he does not do so. However, in the present case, the signed form was already in the hands of the agent when he told the appellant that the additional coverage could be obtained by his making the necessary additions on the basis of the information given him by telephone. When Blanchette agreed not to insist on Raiche returning to his home for the purpose of adding the tractor coverage on the insurance application, he had no means of verifying the correctness of the form as completed. In my view, it is unfair to hold that he should suffer the consequences of Raiche’s failure to complete the form properly.’

Notes: 1. The courts in most USA jurisdictions have also taken the view that an agent who procures insurance and completes the proposal form does so as the agent of the insurer: ‘the insurer cannot rely on incorrectly recorded answers known to the insured where the incorrect answers are entered pursuant to the agents advice, suggestion or interpretation’, Stewart v Mutual of Omaha Insurance Co 817 P2d 44, 53 (Ariz Ct App 1991). 2. Adams has argued that notwithstanding the lack of direct legislative intervention the Newsholme principle might nevertheless be circumvented by a future court. [316] JE Adams, “More Nails in the Coffin of ‘Transferred Agency’” [1999] JBL 215

‘The problems of “the transferred agency”, whereby the insured agent becomes, or is treated as becoming, the proposer’s agent in relation to the completion of the proposal are well known and well documented. The criticisms have not prompted legislative intervention, the ABI Statements of Practice do not address the issue directly [see now the GISC Codes, above, [303] and [304]] and, to date at least, the Insurance Ombudsman accepts the conventional view. The absence of recent litigation is equivocal; the point may be treated as so firmly settled as not to justify proceedings or insurers, as a body, choose not to take the point. The purpose of this article is to suggest that, were it now to be litigated, a combination of legislation, delegated legislation and “quasi-litigation” might help to produce an answer different from that traditionally given’. Brokers Apart from the possible impact of the Financial Services Act 1986 (discussed below), brokers are largely untouched by the new developments. Given their position as agents of the proposer, that is not a surprise (at least not to a lawyer) and indeed almost none of the authorities affected brokers strictly defined. The major problem has been the identification of the status, the foremost example of which is Woolcott v Excess Insurance Co [1979] 1 Lloyds Rep 231 where, although the intermediary was described as a broker, it was seemingly assumed that the knowledge he was found to have should have been communicated to the insurer. The Financial Services Act The 1986 Act, and the concomitant delegated legislation and rules, introduced the concepts of “authorised persons” (ie those allowed to offer financial services) and “appointed representatives”. The latter is “employed” by the former

under a contract of services requiring or permitting him to carry on investment business in the form of procuring contracts with third parties and giving advice to third parties and for whose conduct the authorised person had accepted responsibility in writing. The statute renders the principal responsible for “anything said, done or omitted by the representative as if there had been express authorization” [see section 44]. It imposes vicarious liability on the principal for the representative’s action in breach of the rules in, or made under, the Act. The existence of this imposed responsibility significantly strengthens the arguments against transferred agency for, under the statute, the intermediary is plainly the agent of the insurer, as regards the whole of the conduct. The categorisation of implied authority varies between authors — implied actual authority, apparent authority, ostensible authority, usual authority and customary authority — but for present purposes it is not necessary to pursue the full debate. If the authorised person is obliged to answer for the (mis-)deeds of the appointed representative, it should not be difficult for the proposer’s advisors to fit the circumstances into one or other category of implied authority. What could be wider than the formula for responsibility on the insurer of “anything said, done or omitted”? If the proposer vouchsafes material information to the intermediary, which is either not transmitted on the form to the insurer, or partially, misleadingly, wrongly or ambiguously transmitted, there is surely an act or omission. The first limb of the Newsholme [above, [313]] decision is thus effectively overcome. What, then of the second test, the negligence of the proposer approach? Stone v Reliance Mutual Insurance Society [above, [314]] departed from the 1929 case on this score, because of a finding, on the facts, that the status of the intermediary and the relative unsophistication of the plaintiff’s wife (with whom the inspector dealt) permitted a finding that he had authority to

represent to her that the form had been correctly completed. The structure of section 44, and its generality, gives any appointed representative a wide authority so that nice questions of his, or her, hierarchical ranking can be avoided and reliance on his, or her, standing established so enhancing the prospects of following Stone. The LAUTRO rules forbade the representative to complete the proposal form on behalf of the proposer unless the proposer agrees he should do so. The rules have been adopted by the Personal Investment Authority, doubtless on a temporary basis. The prohibition thus continues into the new scheme. One’s main worry lies in the ease with which, in practice, the agreement of the investor (proposer) “that he may do so” could be procured. Furthermore, if the intermediary does complete the form, how effective in practice is the consequential obligation to ask [sic not “ensure”] the investor “to check that what he has written is correct” and then “to ensure [sic] that the investor reads the form through before signing it”? If the rule is breached, that is an act for which the insurer must answer under section 44 of the 1986 Act. If the rule is observed, that still does not destroy the possibility that the mandatory statutory structure overcomes both limbs of the Newsholme principle. Of course, all these provisions affect only those insurances when negotiated by a broker which constitute investments within the scope of the 1986 Act. There is no reason to suppose that the Financial Services Authority will want to vary these rules, when it takes over in due course. Non-broker Intermediaries The ABI promulgated its Code of Practice for All Intermediaries (Including All Employees of Insurance Companies) Other than Registered Brokers in November 1988, it took effect in January 1989 and was re-issued (with minor amendments) in August 1994. It relates to general

business as defined in the Insurance Companies Act 1982. The general sales principles include the following: “A (ii) [The intermediary] shall make it known that (s)he is — (a) An employee of an insurance company, for whose conduct the company accepts responsibility; or (b) An agent of one company, for whose conduct the company accepts responsibility; or (c) An agent of two or up to six companies, for whose conduct the companies accept responsibility; or (d) An independent intermediary seeking to act on behalf of the prospective policy-holder, for whose conduct the company/companies do not accept responsibility.” Thus, for categories (a) to (c), the holding out goes well beyond section 44 of the Financial Services Act, in that the intermediary is obliged to tell the potential proposer that the insurer stands behind him or her. As the preamble to the Code states “As a condition of membership of the ABI, members undertake to enforce this Code and to use their best endeavors to ensure that all those involved in selling their policies observe its provisions.” Thus ABI insurers should make their non-broker intermediaries, of whatever status, hold out, ie expressly state, that the relevant insurer accepts responsibility for their conduct. Thus, it is urged, neither intermediary nor insurer can exclude their conduct in misdealing with information supplied by a proposer. Under principle C (ii) the intermediary must “”ensure that the consequences of non-disclosure and inaccuracies [in completion of the proposal form] are pointed out to the prospective policy-holder by drawing attention to the relevant statements in the proposal form and by explaining them himself to the prospective policyholder”. Note A (ii) also appears in the Code of Practice for Life Insurance (Non Investment) Business also issued in November 1988.

Here, in the consumer cases, the over-ruling of “transferred agency” is the more readily found. Scrutton LJ’s scepticism “I have great difficulty in understanding how a man who has signed without reading it, a document which he knows to be a proposal for insurance and which contains statements in fact untrue, and a promise that the are true”, [Newsholme, at 382] can be rejected. All intermediaries, save registered brokers, are to have the backing of the member insurer in relation to their conduct in no way restricted to any particular elements of that conduct. The cases already hold that attempts to make the insurer’s representative the agent of the proposer by wording in the proposal fail. So far as consumers are concerned, the Unfair Terms in Consumer Contracts Regulation may also assist. The “Indicative and Illustrative List of Terms Which May Be Regarded as Unfair” in Schedule 3 includes: “(n) limiting the seller’s…obligations to respect commitments undertaken by his agents…”. If that is not sufficient, the general wording of Regulation 4(1), defining as unfair a term “which contrary to the requirement of good faith causes a significant imbalance in the parties rights and obligation under the contract to the detriment of the consumer” also assists the present agreement. The saving for core terms (if clearly expressed) seems not to apply. If unfair, it does not bind the consumer. At the very least, the Regulations should outlaw the wording frequently found in proposals expressly making the insurer’s representative who completes the proposal the agent of the proposer. One can thus conclude that there are further weapons that can be put to good use in the assault on the citadel of “transferred agency”. Even if the role of the ABI in policing its own pronouncements is somewhat pusillanimous, perhaps the Ombudsman may be firmer. One day, of course, a government may belatedly take a part in ending it.’

Notes: 1. It is lamentable that the GISC Codes do not address the harshness of Newsholme and align the law with the expectations of insureds (neither para 19 of the GISC’s Commercial Code nor, more importantly, the General Insurance Code for Private Customers (above, [303]) pick up on the calls for reform made by both Hodgson J and Purchas LJ in Roberts v Plaisted (above, 3.3). Until legislation changes the law, it falls to the Ombudsman to champion the consumer in this regard. 2. As Adams points out (above, [316]), the LAUTRO rules made under the 1986 Act prohibited an agent from completing the proposal form on behalf of the proposer unless the proposer agreed that he should do so. If there was such an agreement the agent was under a duty to ask the proposer to check the form and ensure that he or she read it before signing it. Notwithstanding the FSMA 2000 it seems likely that insureds will remain responsible for any inaccuracies unless non est factum can be pleaded.

3.4 The Duties of an Intermediary In addition to the duties imposed by the FSMA 2000 and the GISC an insurance intermediary is also subject to the duties imposed by the general law:

principally deriving from tort and contract (although it should be noted that agents, as fiduciaries, are also subject to fiduciary duties (see J Lowry and P Rawlings Insurance Law: Doctrines and Principles (Oxford, Hart Publishing, 1999) pp 334–35).

3.4.1 The Agent’s Duty of Care An agent owes a duty of care to the principal and will be liable for any reasonably foreseeable losses consequent upon a breach. Such liability runs concurrently in tort and contract and so the agent may be sued in either: Henderson v Merrett Syndicates Ltd (below, [318]). The relevant limitation period will need to be taken into account when determining which cause of action should be pursued (see J Lowry and P Rawlings, Insurance Law: Doctrines and Principles (Oxford, Hart Publishing, 1999) pp 326–27). As explained by Cantley J in Cherry Ltd v Allied Insurance Brokers Ltd (below, [317]) and by Lord Goff in Henderson v Merrett (below, [318]) the basis of an agent’s liability for breach of the duty of care is the decision of the House of Lords in Hedley Byrne & Co Ltd v Heller & Partners Ltd [1964] AC 464. The court’s determination of the scope of the duty of care will, in turn, determine the measure of damages for its breach (see Aneco Reinsurance Underwriting Ltd v Johnson and Higgins Ltd (below, [319]) where, on the particular facts, the defendants were held liable for the full losses suffered by their clients).

[317] Cherry Ltd v Allied Insurance Brokers Ltd [1978] 1 Lloyd’s Rep 274 [The defendant brokers had acted for the claimants for over 50 years. Dissatisfied with the size of the premiums they were charged given their low claims record, the claimants decided to place their business elsewhere and they instructed the defendants to terminate their policies. At a meeting with the defendants on 13 August 1974 they learnt that the existing insurers refused to cancel cover mid-term. In order to avoid double insurance the claimants cancelled the new policies but failed to inform the defendants. Subsequently, the original insurers agreed to cancel, but the defendants did not pass this information on to the claimants. The claimants suffered a loss and discovered that they were uninsured. They therefore sued the defendants in negligence.] Cantley J: ‘It is contended that they had no duty to be careful. I think in the circumstances of this case they had. The meeting of 13 August was a mutual business meeting from the point of view of both parties; there was nothing casual about it. They were giving information within their specialised knowledge and they knew or ought to have known that it would be taken seriously and acted upon in a transaction of importance. Whatever may have been the position in contract, the situation seems to me to have been covered by the principles as stated by Lord Morris of Borth-y-Gest in the well-known case of Hedley Byrne & Co Ltd v Heller &

Partners Ltd [1964] AC 464 at pp 501 and 502, where he said “I consider that it follows and that it should now be regarded as settled that if someone possessed of a special skill undertakes, quite irrespective of contract, to apply that skill for the assistance of another person who relies upon such skill, a duty of care will arise. The fact that the service is to be given by means of or by the instrumentality of words can make no difference. Furthermore, if in a sphere in which a person is so placed that others could reasonably rely upon his judgment or his skill or upon his ability to make careful inquiry, a person takes it upon himself to give information or advice to, or allows his information or advice to be passed on to, another person who, as he knows or should know, will place reliance upon it, then a duty of care will arise.” Accordingly I hold that the plaintiffs are entitled to succeed in this action. I am not asked to make an award of damages, because the calculation of the appropriate damages is a matter of some intricacy and substance. I am asked to make a declaration, and I do make a declaration, that the plaintiffs are entitled to recover from the defendants as damages such sum as they would have recovered under policy 02CL1532/12 of the General Accident Fire & Life Assurance Corporation Ltd. if that policy had been in force on 29 August, 1974.’

[318] Henderson v Merrett [1995] 2 AC 145 (HL) [The facts are immaterial]. Lord Goff:

Syndicates Ltd

‘The governing principle…I turn immediately to the decision of this House in Hedley Byrne & Co Ltd v Heller & Partners Ltd [above]. There, as is of course well known, the question arose whether bankers could be held liable in tort in respect of the gratuitous provision of a negligently favourable reference for one of their customers, when they knew or ought to have known that the plaintiff would rely on their skill and judgment in furnishing the reference, and the plaintiff in fact relied upon it and in consequence suffered financial loss. Your Lordships’ House held that, in principle, an action would lie in such circumstances in tort; but that, in the particular case, a duty of care was negatived by a disclaimer of responsibility under cover of which the reference was supplied. The case has always been regarded as important in that it established that, in certain circumstances, a duty of care may exist in respect of words as well as deeds, and further that liability may arise in negligence in respect of pure economic loss which is not parasitic upon physical damage. But, perhaps more important for the future development of the law, and certainly more relevant for the purposes of the present case, is the principle upon which the decision was founded. The governing principles are perhaps now perceived to be most clearly stated in the speeches of Lord Morris of Borth-y-Gest (with whom Lord Hodson agreed) and of Lord Devlin. Lord Morris said, at pp 502–03: [His Lordship quoted passages from the speeches of Lords Morris [see above] and Devlin, and continued] From these statements, and from their application in Hedley Byrne, we can derive some understanding of the breadth of the principle underlying the case. We can see that it rests upon a relationship between the parties, which may be general or specific to the particular transaction, and which may or may not be contractual in nature. All of their Lordships spoke in terms of one party having assumed or undertaken a responsibility towards the other…Further, Lord Morris spoke

of that party being possessed of a “special skill” which he undertakes to “apply for the assistance of another who relies upon such skill.” But the facts of Hedley Byrne itself, which was concerned with the liability of a banker to the recipient for negligence in the provision of a reference gratuitously supplied, show that the concept of a “special skill” must be understood broadly, certainly broadly enough to include special knowledge. Again, though Hedley Byrne was concerned with the provision of information and advice, the example given by Lord Devlin of the relationship between solicitor and client, and his and Lord Morris’s statements of principle, show that the principle extends beyond the provision of information and advice to include the performance of other services. It follows, of course, that although, in the case of the provision of information and advice, reliance upon it by the other party will be necessary to establish a cause of action (because otherwise the negligence will have no causative effect), nevertheless there may be other circumstances in which there will be the necessary reliance to give rise to the application of the principle. In particular, as cases concerned with solicitor and client demonstrate, where the plaintiff entrusts the defendant with the conduct of his affairs, in general or in particular, he may be held to have relied on the defendant to exercise due skill and care in such conduct. In subsequent cases concerned with liability under the Hedley Byrne principle in respect of negligent misstatements, the question has frequently arisen whether the plaintiff falls within the category of persons to whom the maker of the statement owes a duty of care. In seeking to contain that category of persons within reasonable bounds, there has been some tendency on the part of the courts to criticise the concept of “assumption of responsibility” as being “unlikely to be a helpful or realistic test in most cases” (see Smith v Eric S Bush [1990] 1 AC 831, 864–65, per Lord Griffiths; and see also Caparo Industries plc v

Dickman [1990] 2 AC 605, 628, per Lord Roskill). However, at least in cases such as the present, in which the same problem does not arise, there seems to be no reason why recourse should not be had to the concept, which appears after all to have been adopted, in one form or another, by all of their Lordships in Hedley Byrne (see, eg, Lord Reid, at pp 483, 486 and 487; Lord Morris (with whom Lord Hodson agreed), at p 494; Lord Devlin, at pp 529 and 531; and Lord Pearce at p 538). Furthermore, especially in a context concerned with a liability which may arise under a contract or in a situation “equivalent to contract,” it must be expected that an objective test will be applied when asking the question whether, in a particular case, responsibility should be held to have been assumed by the defendant to the plaintiff: see Caparo Industries plc v Dickman [1990] 2 AC 605, 637, per Lord Oliver of Aylmerton. In addition, the concept provides its own explanation why there is no problem in cases of this kind about liability for pure economic loss; for if a person assumes responsibility to another in respect of certain services, there is no reason why he should not be liable in damages for that other in respect of economic loss which flows from the negligent performance of those services. It follows that, once the case is identified as falling within the Hedley Byrne principle, there should be no need to embark upon any further enquiry whether it is “fair, just and reasonable” to impose liability for economic loss — a point which is, I consider, of some importance in the present case. The concept indicates too that in some circumstances, for example where the undertaking to furnish the relevant service is given on an informal occasion, there may be no assumption of responsibility; and likewise that an assumption of responsibility may be negatived by an appropriate disclaimer. I wish to add in parenthesis that, as Oliver J recognised in Midland Bank Trust Co Ltd v Hett, Stubbs & Kemp [1979] Ch 384, 416F–G (a case concerned with

concurrent liability of solicitors in tort and contract, to which I will have to refer in a moment), an assumption of responsibility by, for example, a professional man may give rise to liability in respect of negligent omissions as much as negligent acts of commission, as for example when a solicitor assumes responsibility for business on behalf of his client and omits to take a certain step, such as the service of a document, which falls within the responsibility so assumed by him.’

[319] Aneco Reinsurance Underwriting Ltd v Johnson and Higgins Ltd [2002] 1 Lloyd’s Rep 157 (HL) [The facts appear from the speech of Lord Steyn]. Lord Steyn: ‘1. The shape of the appeal The central issue in this case is not one of high legal principle but an evaluative one involving matters of fact and degree. This would not have been fully apparent when the Appeal Committee granted leave to appeal. The broad question is whether London reinsurance brokers, who were in breach of duty to a Bermudian reinsurance company, are liable only for the reinsurance cover which the company lost (US$11 m.), or for the total losses which the company suffered on the transaction (US$35 m.). This in turn depends on an assessment whether on the facts of the case it is governed by the “scope of the duty” principle applied by the House in Banque Bruxelles Lambert SA v Eagle Star Insurance Co Ltd [1997] AC 191, known as South Australia Asset Management Corporation v York Montague Ltd (“SAAMCO”) or whether the brokers had undertaken or assumed a duty to advise the company as to what course of action they should take.

II. The Bullen treaty and the reinsurance contracts Mr Bullen was the underwriter of four syndicates at Lloyd’s which wrote marine excess of loss business, ie they reinsured losses of other marine insurers so far as those losses exceeded a particular level. In the autumn of 1998 Mr Bullen discussed with Mr Forster, an experienced broker with Johnson and Higgins Ltd, the idea of a proportional reinsurance of his excess of loss account. Mr Forster drafted a treaty (“the Bullen treaty”) on a basis which he believed would be attractive to the Bullen syndicates. He had identified Aneco Reinsurance Underwriting Ltd. (now in liquidation) as potential reinsurers of the Bullen treaty. In truth what was contemplated was a retrocession of this treaty but I will adopt the description of it as reinsurance used during the proceedings. … Johnson and Higgins were acting as Mr Bullen’s brokers in the first or (from Aneco’s point of view) inwards transaction and as Aneco’s brokers in the second or outwards transaction. Mr Forster knew from the start that if satisfactory outwards reinsurance was not available in the market Aneco would not have proceeded. Mr Forster said in due course at the trial that “the whole thing would have collapsed”… Unfortunately Mr Forster negligently failed properly to present the risk to Aneco’s reinsurers, some of whom subsequently avoided the policies as they were entitled to do. Euphemistically Mr Forster represented to Aneco’s reinsurers that the Bullen treaty was a quota share treaty when it was in fact a fac/oblig treaty. The difference is that a quota share treaty is not facultative as far as the reassured (a person in the position of Bullen) is concerned: he must cede a set proportion of every risk which falls within the limits of the contract, so that everything which meets those

criteria is automatically ceded. By contrast fac/oblig treaties are plainly open to abuse. The reassured is able to put onto his reinsurer the least attractive pieces of qualifying business in his book, while keeping what he considers to be the best business for himself. A reinsurer will tend only to reinsure another underwriter on fac/oblig terms if he has considerable trust in the way that his reassured will use it. It is common ground, now, that Mr King would not have agreed to lead the reinsurance of a fac/oblig treaty, and that on a proper presentation of the risk, it would have been impossible to get enough underwriters to subscribe the reinsurance slip, so that the reinsurance that Mr Crawley desired was never available in the market. If Mr Forster had made the enquiries, presentation and disclosure that he should have made, he would have discovered that the outwards reinsurance cover on which Mr Crawley to his knowledge relied from the start was never available. In the event, Aneco suffered a loss on the Bullen treaty of more than US$35 m., of which they would have recovered US$11 m. from their reinsurers if the reinsurance which Aneco had asked for and which Johnson and Higgins claimed to have obtained had been effective. The brokers received the usual 3 per cent brokerage under the Bullen treaty and 10 per cent. in respect of the six excess of loss contracts.

III. The High Court proceedings Aneco sued the brokers in negligence. Aneco formulated its claim for damages on two alternative bases. Its primary case was a claim for all losses which it had in fact suffered by entering into the reinsurance of the Bullen treaty. Aneco put forward this claim on the basis that the brokers had wrongly advised them that the reinsurance was available in the market, and that this advice led them to enter into the Bullen treaty. An indispensable part of this way of putting

the claim was that in truth alternative security was never available. The secondary case of Aneco was a claim for all the sums which would have been payable under the outwards reinsurance if it had been in place. …

V. The issues before the House Before the House the Court of Appeal’s conclusions on the non- availability of alternative reinsurance cover was accepted. It follows that Mr Forster’s advice to Aneco that reinsurance cover was available in the market was wrong and was negligently given. In these circumstances the principal question is: Is the correct measure of damages all of Aneco’s losses under the Bullen treaty or is the correct measure equal to the recovery which Aneco would have made under the reinsurance contracts but was unable to make to the extent that those have been avoided? …

VII. The law Given that this case can be decided by applying settled principles, I do not propose to examine any problems which do not arise. Nevertheless, I must set out, without examination, the contours of established doctrine. In the leading judgment in SAAMCO [1997] AC 191 Lord Hoffmann illustrated “the scope of duty” concept with an example. He said, at p 213D: “A mountaineer about to undertake a difficult climb is concerned about the fitness of his knee. He goes to a doctor who negligently makes a superficial examination and pronounces the knee fit. The climber goes on the expedition, which he would not have undertaken if the

doctor had told him the true state of his knee. He suffers an injury which is an entirely foreseeable consequence of mountaineering but has nothing to do with his knee.” Lord Hoffmann said that on the usual principle the doctor is not liable. Lord Hoffmann supported his reasoning saying that, if the contrary were the case, the paradoxical situation would arise that the liability of a person who warranted the accuracy of the information would be less than that of the person who gave no such warranty but failed to take reasonable care: at pp 213H–214A. Lord Hoffmann generalised the principle as follows, at p 213C–F: “It is that a person under a duty to take reasonable care to provide information on which someone else will decide upon a course of action is, if negligent, not generally regarded as responsible for all the consequences of that course of action. He is responsible only for the consequences of the information being wrong. A duty of care which imposes upon the informant responsibility for losses which would have occurred even if the information which he gave had been correct is not in my view fair and reasonable as between the parties. It is therefore inappropriate either as an implied term of a contract or as a tortious duty arising from the relationship between them. The principle thus stated distinguishes between a duty to provide information for the purpose of enabling someone else to decide upon a course of action and a duty to advise someone as to what course of action he should take. If the duty is to advise whether or not a course of action should be taken, the adviser must take reasonable care to consider all the potential consequences of that course of action. If he is negligent, he will therefore be responsible for all the foreseeable loss which is a consequence of that course of action having been taken. If his duty is only to supply information, he must take reasonable care to ensure that

the information is correct and, if he is negligent, will be responsible for all the foreseeable consequences of the information being wrong.” The House has twice followed and applied the law as stated in SAAMCO: see Nykredit Mortgage Bank plc v Edward Erdman Group Ltd (No 2) [1997] 1 WLR 1627 and Platform Home Loans Ltd v Oyston Shipways Ltd [2000] 2 AC 190. In the latter case Lord Hobhouse of Woodborough summarised the SAAMCO principle by saying “it is the scope of the tort which determines the extent of the remedy to which the injured party is entitled” at p 209B. There was an interesting debate during the hearing of the appeal on the validity or otherwise of Lord Hoffmann’s paradox. In a closely reasoned case note Professor Jane Stapleton has argued that conceptually there is no paradox: “Negligent Valuers and Falls in the Property Market” (1997) 113 LQR 1. In the interests of brevity, and doing less than justice to the full rigour of the argument (at pp 3–5), I cite only one passage, at p 5: “Buying a warranty from one’s contracting party is a completely different deal than obtaining an obligation of care. If one accepts that the law of contract damages should not allow the plaintiff to shift the bad bargain on to the defendant, it is not paradoxical that the fate into which the former deal locks its buyer might be worse than that of the person protected by the latter. In terms of the protection of the law of contract damages, a contractual warranty can leave you worse off than an entitlement to due care.” …

VIII. The correct characterisation of the case …

The starting point of the enquiry is not in doubt. If the brokers had carefully performed their duty to report on the availability of reinsurance they would inevitably have reported to Aneco that reinsurance cover was not available in the market. In that event, Aneco would not have entered into the Bullen treaty. The issue is simply: Did the brokers undertake a duty to advise Aneco as to what course of action they should undertake? The argument on behalf of the brokers was that they only undertook a duty to exercise reasonable care to obtain the reinsurance ordered and to report the result of their endeavours. Evans LJ, who has vast experience of the way in which reinsurance business is transacted, gave the answer to this argument. He observed that it would be “highly artificial to derive from the evidence any suggestion that Mr Forster was not advising Mr Crawley what course to take”: at para 78. There was ample material to support this conclusion. Only one item of evidence need be cited. In his evidence Mr Forster accepted that the brokers were advising Mr Crawley as to what reinsurance was available and as to the state of the market. He said: “[A.] Yes, I think we were advising him of what was available then, and we were advising him about the state of the market at that time, as well. [Q.] Yes, quite, you were advising him as to the state of the market? [A.] Yes.” The core of the reasoning of Evans LJ was at paras 82–84: “…the fact that no reinsurance cover was available in the market is important, because it introduces an additional head of breach of duty by Johnson and Higgins. They are liable not merely for failing to obtain effective cover on the terms which they reported to Aneco, but also for failing to report that no cover could be obtained.

The last factor in particular means in my judgment that the Banque Bruxelles principle — compensating the claimant only for the consequences of the advice or information being wrong — fails to provide proper compensation in the present case. Aneco is also reasonably entitled to compensation for Johnson and Higgins’ failure to report correctly the current market assessment of the reinsurance risks which Aneco was proposing to undertake. Those risks were central to Aneco’s decision and Mr Forster took it upon himself to advise Mr Crawley with regard to them. This is far removed from the lender/valuer relationship and even from the client/professional adviser relationship to which the Banque Bruxelles case applies, and even more so from the doctor and mountaineer. I therefore would hold that Aneco is entitled to recover damages for the whole of the losses which it suffered in consequence of entering into the Bullen treaty, acting on Johnson and Higgins’ advice with regard to the availability of reinsurance (retrocession) and therefore on the current market assessment of the risk.” For my part this reasoning is convincing… The contrary reasoning of Aldous LJ, and the arguments of Counsel for the brokers, are in my view based on an artificial and unrealistic distinction between reporting on the availability of reinsurance in the market and reporting on the assessment of the market on the risks inherent in the Bullen treaty. These are two sides of the same thing: they are inextricably intertwined. If the brokers had advised Aneco of the non availability of reinsurance cover in the market, that would inevitably have revealed to Aneco the current market assessment of the risk. There was no other credible reason for reinsurance being unavailable. On the evidence Evans LJ was correct to conclude that the brokers’ breach of duty was their negligent advice “with regard to the availability of reinsurance (retrocession) and therefore

on the current market assessment of the risk”. In my view the conclusion of Evans LJ is supported by the commercial realities and inherent probabilities in the relationship between broker and reinsured revealed by the documentary and oral evidence. Counsel for the brokers placed great weight on the argument that the conclusion of the majority places a broker, circumstanced in a dual capacity as Mr Forster was, in an invidious position. He argued that the difficulty lies in holding that the broker, who owes a duty to the insured to place the insurance, is simultaneously under a duty of care to the insurer to provide advice to him on whether or not to write the insurance at all. The answer is clear. Any problem of the brokers arising from the performance of their dual functions in this case was entirely of their own making. It cannot divert the House from arriving at the inescapable conclusion on the facts that the brokers assumed a duty to advise Aneco as to what course to take. In the result the brokers’ failure to advise that reinsurance was unavailable in the market resulted in a recoverable loss of US$35 m. The width of the duty assumed by the brokers is determinative of this being the correct measure of damages. Ultimately, on matters of fact the question is on which side of the line drawn in SAAMCO the present case falls. In my view the majority of the Court of Appeal came to the correct conclusion. The brokers were fortunate in obtaining leave to appeal to the House on what turned out to be issues of fact. Nevertheless, it was necessary to give the closest attention to all the arguments deployed during a three day hearing. Having done so my view is that the arguments of the brokers must be rejected.

IX. Disposal I would dismiss the appeal with costs.’

3.4.2 Agents Completing Proposal Forms We saw above that it is common for agents or brokers to complete proposal forms on behalf of applicants and that the Newsholme principle holds that an agent’s knowledge about the insured risk will not necessarily be imputed to the insurers. The question that arises is what liability, if any, does an agent have to the insured where the agent fails to pass on material information to the insurers that was disclosed by the insured at the proposal stage? [320] O’Connor v BDB Kirby & Co [1972] 1 QB 90 (CA) [The claimant instructed the defendant broker to arrange vehicle insurance for his new car. The broker completed the proposal form on the basis of information supplied by the claimant but inadvertently stated that the car was garaged whereas, in fact, it was parked on the street. The insurers repudiated liability and the insured sued the broker]. Davies LJ: ‘The fact that the assured read that form and failed or omitted to read it properly, and did not notice, as he said he did not notice, that the form was wrongly filled in with regard to the garage, was the ground upon which the judge found the assured one-third to blame for his loss. A division of liability on those lines in a case of this kind is a somewhat novel thing, and I do not think that it ought to have been a

ground for a division of liability…But, in my view…it was the duty of the assured to have read that form: it was his application, he signed it and, if he was so careless as not to have read it properly, then in my opinion he has only himself to blame for his loss. On those two grounds, and particularly the latter, I would allow this appeal and enter judgment for the broker and the firm.’

Karminski LJ: ‘I agree. When the matter was before the judge, although the assured was represented by counsel, the broker was in person representing also the firm. In the result, therefore, the judge had not the advantage we have had here of a full and careful argument on behalf of the broker and the firm. The proposal form is what I imagine would be the usual form, and amongst other questions is one directed as to the place or places where the car is garaged, whether normally garaged in a private garage, a public garage or in the open. The premium, we understand, varies accordingly — not surprisingly. The broker put in “yes” against the words “private garage,” and the premium was adjusted accordingly. I am not at all persuaded that that was done deliberately in order to attract a lower premium. I am much more inclined to think that it was a pure mistake; if a word of censure is applicable, it was a piece of carelessness on the broker’s part… What follows seems to be the vital matter here. The broker told the assured to read through the proposal form and to check that everything was accurate. The proposal form contained a large number of answers dealing with other questions. The assured apparently read it through and signed it. The form itself stressed the importance of correct answers to the questions asked in relation to the policy of insurance.

I have come to the conclusion…that the sole, effective cause of the loss here was the assured’s failure to check the entire contents of the proposal form, failing in consequence to notice the error with regard to the garage facilities. For those reasons, I have no doubt at all that the decision of the judge was wrong, and I agree that this appeal succeeds and the judgment below must be set aside.’

Note: 1. In reaching its decision in O’Connor v Kirby the Court of Appeal applied Biggar v Rock Life Assurance Co (above, [312]) together with Newsholme (above, [313]). The effective cause of the insured’s loss was his own failure to correct the mistake. However, following the enlargement of the scope of the Hedley Byrne principle by the House of Lords in Henderson v Merrett (above, [318]), the decision in O’Connor might well be restrictively viewed by a future court. 2. Indeed, the modern approach towards an agent’s or broker’s liability in negligence is illustrated by the decision in McNealy in which the scope of a broker’s duty of care was considered by the Court of Appeal. [321] McNealy v The Pennine Insurance Co Ltd West Lanc Insurance Brokers Ltd and Carnell [1978] 2 Lloyd’s Rep 18 (CA) [The facts appear from the judgment].

Denning LJ: ‘This is an interesting point which may often occur. Mr McNealy had served in the Navy and become expert on the guitar. After leaving the Navy he had many jobs. He eventually became a repairer of property. But he had a sideline as a player on the guitar. He went on cruise ships as a member of the band. In 1971 he bought a Triumph motor car. He wanted to insure it. He did not want immediate insurance because he was going to Italy to play the guitar. It was a six-week tour. He had a singer with him, Miss Whittaker. They were both to join a band in Italy. He was not taking his car but he wanted it insured so that he could pick it up at Bristol on the way back and then take Miss Whittaker to her home. So he arranged the insurance through brokers ready for his return to England. They got back to Bristol on 4 November 1971. While taking Miss Whittaker home in the car, he ran into a wall and damaged the car. Miss Whittaker was also injured. Police came up. They wondered what he was doing with a guitar in the back of his car. They thought that he might have stolen it; but he satisfied them that he was a musician. So all was well on that score. But he wanted to claim on his insurance cover, both for the damage to the car and also to meet a claim by Miss Whittaker for her injuries. He claimed against The Pennine Insurance Co Ltd, but they said that they were not liable. So he turned round and went against his brokers, a company called West Lancs Insurance Brokers Ltd. The man in charge there was a Mr Carnell. Mr McNealy said: “If the insurance company are not liable to me on my insurance, I want to sue the brokers”. That is the point in the case. Are the brokers liable? The facts are these: In June 1971, before leaving for Italy, Mr McNealy went to the office of the brokers. He told them that he wanted to effect an insurance ready on his return to England. The broker, Mr Carnell, and his company were in

touch with several insurance companies. He suggested to Mr McNealy that he should insure with the Pennine Insurance Co. Now the Pennine Insurance Co offered very low rates to a limited class of motorists, but they excluded many others. The broker had in his office a leaflet headed “Underwriting instructions” issued by the Pennine Insurance Co. It set out a list of “Risks not acceptable”. I will not go through them all, but a good many ordinary people were excluded from this low-cost insurance. Among those excluded there were “bookmakers, jockeys and others connected with racing”, “whole or part-time musicians”, “journalists and press photographers”, “students” and “service personnel”. Any person who had not been resident in England for 10 years was not acceptable. All those people were not acceptable to the Pennine Insurance Co for this low-cost premium. The broker knew all about those exclusions. He knew perfectly well that part-time musicians were not acceptable risks. Nevertheless when Mr McNealy went to see him, he simply asked him “What is your occupation?” Mr McNealy said “Property repairer”. The proposal form asked for “Full details of occupation”. The answer was simply “Property repairer”. At the trial a question arose as to how and when the proposal form was filled in, but we need not go into it. The form produced to the Court was filled in by the broker himself: but it was signed by Mr McNealy or on his behalf. The important thing is that Mr McNealy was simply asked “What is your occupation?”, and he said “Property Repairer”. On that answer, the risk was acceptable at low rates. The insurance company accepted it. Mr McNealy believed himself to be covered by a comprehensive insurance which also covered passengers. At the trial of the case, it was accepted by both sides that the insurance company were not liable. The reason for their non-liability was because the broker was the agent of the assured. It is well-settled that in all matters relating to the

placing of insurance the insurance broker is the agent of the assured, and of the assured only…In the present case the broker knew perfectly well that a part-time musician was excluded from this risk. Then I go on to ask: Ought that to have been disclosed to the insurance company? Clearly it should have been. It was a most material fact. All facts are material which are, to the knowledge of the proposed assured, regarded by the insurers as material: and that extends to the knowledge of his broker also. Mr Carnell, the broker, knew that it was very material for the insurance company to know that Mr McNealy was a part-time musician. If the insurance company had known that he was a part-time musician, they would not have given him cover at this low premium. They would not have given him any cover at all. Not having a remedy against the insurance company, Mr McNealy said, “If that is so, surely the broker, my agent, is liable”. Certainly he is liable. It was clearly the duty of the broker to use all reasonable care to see that the assured, Mr McNealy was properly covered. An obvious step in the course of doing his duty would have been to say to Mr McNealy: The Pennine will not cover you if you are a full or part-time musician, a bookmaker, a jockey, or anything to do with racing. He ought to have gone through the whole list with Mr McNealy and said: You are not going to be accepted if you are one of these categories because, if you are, the insurance company can get out of it. I am afraid the broker did not do his duty. He did not go through that list with Mr McNealy at all. He simply asked him what was his occupation, and Mr McNealy said “property repairer”. The broker ought to have gone on and asked: “Have you ever been or are you a full or part-time musician?”, and the answer would certainly have been “Yes”. On the answer being “Yes”, the broker should have said: It is no good trying to insure with the Pennine. You had better go to one of the companies who are ready to insure full or part-time

musicians, but that will no doubt be at a higher premium. The broker did not do that at all. In other words, he did not do all that was reasonable to see that Mr McNealy was properly covered. It seems to me that that quite clearly was a breach of duty, and that breach of duty was the cause of all the trouble that Mr McNealy found himself in. I think the Judge was quite right. The broker was liable for not taking proper care to effect the insurance, and he is therefore liable for the full amount of the claim.’

[322] Warren v Henry Sutton & Co [1976] 2 Lloyd’s Rep 276 [The claimant, Warren, instructed his brokers to add a friend, Wright, to his policy as an additional driver. The brokers told the insurers that Wright had ‘no accidents, convictions, or disabilities’ without first checking this with the claimant. In fact Wright did have previous convictions. They were involved in an accident and the insurers repudiated liability on the ground of misrepresentation. The claimant sued the brokers on the basis that they were responsible for the misrepresentation in that they failed to ask the relevant questions about Wright’s record.] Sir John Pennycuick: ‘Assuming then that there was no positive statement by Mr Warren to Mr Sutton, can one say the mere omission by Mr Warren to communicate Mr Wright’s record to him occasioned Mr Sutton’s misrepresentation? It seems to me that the answer to that is in the negative. Mr Sutton was under a duty to obtain cover for Mr Wright, if possible, to make such inquiries as were necessary to that end and to

make a suitable statement to the Legal and General. His misrepresentation was due to his omission to make any inquiries and not to the omission of Mr Warren to communicate to him what he knew about Mr Wright’s record. The most that can be said on behalf of Mr Sutton in this respect is that Mr Warren might have put him on his guard. But that I think is insufficient to absolve Mr Sutton from making inquiries and giving a truthful statement to the Legal and General. In truth, Mr Sutton’s reason for not making inquiries was apparently the principal Mr Warren not giving his account promptly.’

3.4.3 Contractual Liability The liability of a broker or agent in contract depends upon the express or implied terms of the agreement entered into with the principal. As indicated above, the intermediary is also under a duty to discharge contractual obligations with reasonable care and skill. 323 London Borough of Bromley v Ellis [1971] 1 Lloyd’s Rep 97 (CA) [Ellis purchased a car from D who agreed to transfer the car’s insurance to him. Ellis instructed the brokers through whom the insurance had been arranged to effect the transfer. The brokers obtained a proposal form and issued a cover note. Some four months later the brokers submitted the proposal form to the insurers who then queried an answer in the proposal concerning Ellis’s claims record. The brokers did not contact Ellis about the query and subsequently the

insurers informed them that cover would be cancelled and that further cover notes should not be issued. The brokers failed to relay this information to Ellis. Subsequently, he was involved in an accident and learnt that he was uninsured]. Lord Denning MR: ‘The brokers were, I think, under a duty of care to look after Mr Ellis’s interests. I know that the brokers were not his agents. They were agents for the insurance company; but, nevertheless, they were also under a duty to use reasonable care to Mr Ellis. He had asked them to arrange the transfer of the insurance. They had undertaken the duty of arranging the transfer. They had taken the proposal form from him and got it filled in. They were clearly under a duty to arrange the transfer with reasonable care so as to see that he was protected. They failed in many respects, one after the other. They ought to have sent off the proposal form straightaway to the insurance company — or, at all events, sent it within the first 30 days of the cover note. They did not do so. They did not do it until 11 November. That was far too late. Then, when the query was raised, they did not do anything about it. It is clear to me that this want of due care was the reason why he was not insured on 26 February 1967. I think that Mr Ellis was entitled to indemnity from the brokers for their failure to use reasonable care. I would dismiss the appeal, accordingly.’

Note: In Youell v Bland Welch & Co Ltd, The Superhulls Cover Case (No 2) [1990] 2 Lloyd’s Rep 431 at 445, Phillips J accepted counsel’s submission that a broker’s duties could be reduced to three propositions:

‘Mr. Sumption referred me to authorities that establish that an insurance broker’s duties include the following: (i) He must ascertain his client’s needs by instruction or otherwise. (ii) He must use reasonable skill and care to procure the cover which his client has asked for, either expressly or by necessary implication. (iii) If he cannot obtain what is required, he must report in what respects he has failed and seek his client’s alternative instructions. McGillivray & Parkington, Insurance Law, 8th edn. (1988), para 385; Callendar v Oelreichs (1838) 5 Bing NC 58 [132 ER 1026]; Hood v West End Motor Car Packing Co [1917] 2 KB 38 at p 47 per Lord Justice Scrutton; Mitor Investment (Pty) Ltd. v General Accident Fire & Life Assurance Corporation (1984) WAR 365 at pp 37 (Supreme Court of Western Australia); Eagle Star Insurance Co Ltd v National Westminister Finance Australia Ltd (1985) 58 ALR 165 at p 173 (PC)’

3.5 Reform Calls for reform have also long been made in relation to the duties and status of insurance intermediaries. For example, although the courts have accepted the Newsholme principle as a correct statement of the law it has nevertheless attracted significant criticism as running counter to the reasonable expectations of insureds and should therefore be reversed. The Law Reform Committee Fifth Report Cmnd 62 (1957) recommended that: ‘any person who solicits or negotiates a contract of insurance shall be deemed…to be the agent of the insurers, and that the knowledge of such person shall be deemed to be the knowledge of the insurers.’

This is now the position in Australia. The Insurance (Agents and Brokers) Act 1984 (Cth) implemented the recommendations of the Australian Law Reform Commission (ALRC 16). It provides that all insurance intermediaries apart from brokers should operate under written authorisation from insurers and that insurers are responsible for the conduct of their agents. [324] (Australian) Insurance (Agents and Brokers) Act 1984 (Cth) (as amended) ‘Part II — General 10 Insurance intermediaries other than brokers to operate under written agreements (1) An insurance intermediary (other than an insurance broker) shall not arrange, or hold the intermediary out as entitled to arrange, a contract of insurance as agent for an insurer unless an agreement in writing between the intermediary and the insurer authorizes the intermediary to arrange: (a) that contract; (b) any contracts of insurance; or (c) a class of contracts of insurance in which that contract is included; as agent for that insurer. (2) An insurer shall not cause or permit an insurance intermediary (other than an insurance broker) to arrange, or hold the intermediary out as entitled to arrange, a contract of insurance as agent for that insurer unless an agreement in writing between the insurer and the intermediary authorizes the intermediary to arrange: (a) that contract;

(b) any contracts of insurance; or (c) a class of contracts of insurance in which that contract is included; as agent for that insurer. (2A) An agreement referred to in this section must specify whether an insurance intermediary can appoint a person as the intermediary’s agent for the purposes of the agreement. (3) Subsections (1) and (2) do not apply in relation to any act or thing done by an employee of an insurer in the course of performing his or her duties as such an employee. (4) Where an insurance intermediary to whom subsection (1) applies proposes, or holds the intermediary out as entitled, to arrange, or has arranged, a contract of insurance as agent of an insurer, ASIC, or the intending insured or the insured, may request the intermediary to give ASIC, the proposed insured or the insured a copy of the agreement authorising the intermediary to arrange that contract, and, if such a request is made, the intermediary shall comply with the request within 7 days after the day on which the request is received by the intermediary. (5) ASIC may request an insurer to give ASIC a copy of the agreement referred to in subsection (2) that is in force between the insurer and an insurance intermediary referred to in the request, and, if such a request is made, the insurer shall comply with the request within 7 days after the day on which the request is received by the insurer. (6) The validity of a contract of insurance is not affected by a contravention of this section. 11 Liability for conduct of agents and employees (1) This section applies to any conduct of an employee or agent of an insurer:

(a) on which a person in the circumstances of the insured or intending insured could reasonably be expected to rely; and (b) on which the insured or intending insured in fact relied in good faith. (1A) An insurer is responsible, as between the insurer and the insured or intending insured, for the conduct of an employee of the insurer in relation to any matter relating to insurance, whether or not the employee acted within the scope of his or her employment. (1B) If a person is the agent of one insurer only, the insurer is responsible, as between the insurer and the insured or intending insured, for the conduct of the agent in relation to any matter relating to insurance, whether or not the agent acted within the scope of the authority granted by the insurer. (1C) If: (a) a person who is the agent of more than one insurer is the agent of one insurer only in respect of a particular class of insurance business; and (b) the person engages in the conduct in relation to any matter relating to that class of insurance business; the insurer who granted the agency agreement in respect of that class of insurance business is responsible for the conduct, as between the insurer and the insured or intending insured, whether or not the agent has acted within the scope of the authority granted by the insurer. (1D) If: (a) a person is the agent of more than one insurer in respect of a particular class of insurance business; and (b) the person engages in the conduct in relation to any matter relating to that class of insurance; the insurers are jointly and severally responsible for the conduct, as between themselves and the insured or

intending insured, if the agent has acted beyond the scope of the authority granted by any of the insurers. (1E) If: (a) a person is the agent of more than one insurer in respect of a particular class of insurance business; and (b) the person engages in the conduct in relation to a matter relating to that class; and (c) the person, in so engaging, has acted within the scope of the authority granted by one only of those insurers; that insurer is responsible for the conduct, as between the insurer referred to in paragraph (c) and the insured or intending insured. (1F) If: (a) a person is the agent of more than one insurer in respect of a particular class of insurance business; and (b) the person engages in the conduct in relation to a matter relating to that class; and (c) the person, in so engaging, has acted within the scope of the authority granted by some only of those insurers; the insurers referred to in paragraph (c) are jointly and severally responsible for the conduct, as between themselves and the insured or intending insured. (1G) If: (a) a person is the agent of more than one insurer; and (b) the person engages in the conduct in relation to any matter relating to a class of insurance business in which the person is not the agent of any of those insurers; the insurers are jointly and severally liable for the conduct, as between themselves and the insured or intending insured, despite the fact that the agent acted

outside the scope of the authority granted by any of the insurers. (1H) If: (a) a person (the principal agent) is the agent of an insurer; and (b) the principal agent appoints a second person (the sub-agent) to act as agent of the principal agent; then, for the purpose of determining the ultimate responsibility of the insurer under this section, the actions of the sub-agent are to be taken to be the actions of the principal agent: (c) whether the agency agreement entered into between the principal agent and the insurer permitted or forbade the principal agent to appoint the sub-agent; and (d) whether or not the sub-agent acted within the scope of his or her authority. (1J) If: (a) a person is the agent of at least one insurer in respect of life insurance business; and (b) the person is the agent of at least one other insurer in respect of another class of insurance business (general insurance business); the provisions of this section do not operate: (c) if the person engages in the conduct in relation to life insurance business — so as to make any insurer referred to in paragraph (b) responsible for the conduct; and (d) if the person engages in conduct in relation to general insurance business — so as to make any insurer referred to in paragraph (a) responsible for the conduct. (1K) If: (a) a person is the agent of more than one insurer in respect of a particular class of insurance business; and

(2)

(3)

(4) (5)

(b) the person engages in the conduct in relation to a matter relating to that class; and (c) any one or more of the insurers enters or enter into a contract of insurance as a result of the conduct; then, for the purposes of this section, the agent is taken, in respect of the conduct, to have acted within the scope of the authority granted by the insurer or each insurer who so entered into a contract of insurance. The responsibility of an insurer under subsection (1A), (1B), (1C), (1D), (1E), (1F), (1G) or (1H) extends so as to make the insurer liable to an insured or intending insured in respect of any loss or damage suffered by the insured or intending insured as a result of the conduct of the agent or employee. Subsections (1A), (1B), (1C), (1D), (1E), (1F), (1G), (1H) and (1J) and (2) do not affect any liability of an agent or employee of an insurer to an insured or intending insured. An agreement, in so far as it purports to alter or restrict the operation of subsection (1A), (1B), (1C), (1D), (1E), (1F), (1G), (1H), (1J) or (2), is void. An insurer shall not make, or offer to make, an agreement that is, or would be, void by reason of the operation of subsection (4).

12 Certain insurance intermediaries to be agents of insurers (1) Subject to this section, an insurance intermediary shall be deemed, in relation to any matter relating to insurance and as between an insured or intending insured and an insurer, to be the agent of the insurer and not of the insured or intending insured. (2) Subsection (1) does not apply to a general insurance broker in relation to any matter relating to general insurance business.

(3) Subsection (1) does not apply to a life insurance broker in relation to any matter relating to life insurance business. (4) Subsection (1) does not affect any liability to which, if that subsection had not been enacted, an insurer would have been subject in respect of the conduct of an insurance intermediary. 13 Representations etc. by intermediaries (1) A person to whom this section applies shall not with intent to deceive make a false or misleading statement: (a) as to any amount that would be payable in respect of a proposed contract of insurance; or (b) as to the effect of any of the provisions of a contract of insurance or of a proposed contract of insurance. (1A) A reference in subsection (1) to making a misleading statement includes a reference to omitting to disclose matter that is material to a statement. (2) A person to whom this section applies shall not with intent to deceive, in relation to a proposed contract of insurance: (a) write on a form, being a form that is given or sent to the insurer, matter that is material to the contract and is false or misleading in a material particular; (b) omit to disclose to the insurer matter that is material to the proposed contract; (c) advise or induce the intending insured to write on a form, being a form that is given or sent to the insurer, matter that is false or misleading in a material particular; or (d) advise or induce the intending insured to omit to disclose to the insurer matter that is material to the proposed contract. (3) A person to whom this section applies shall not with intent to deceive, in relation to a claim under a contract of insurance:

(a) fill up, in whole or in part, a form, being a form that is given or sent to the insurer, in such a way that the form is false or misleading in a material particular; (b) omit to disclose to the insurer matter that is material to the claim; (c) induce the insured to fill up, in whole or in part, a form, being a form that is given or sent to the insurer, in such a way that the form is false or misleading in a material particular; or (d) advise or induce the insured to omit to disclose to the insurer matter that is material to the claim. (4) An act done in contravention of subsection (1) or (2) constitutes an offence against the subsection concerned notwithstanding that a contract of insurance does not come into being. (5) The persons to whom this section applies are: (a) insurance intermediaries; and (b) agents and employees of insurance intermediaries and of insurers. Penalty:Imprisonment for 2 years…’

Notes: 1. New Zealand has also reformed its law governing insurance intermediaries. The New Zealand Insurance Law Reform Act 1977, section 10(1) provides that ‘a representative of an insurer who acts for the insurer during the negotiation of any contract of insurance, and so acts within the scope of his actual or apparent authority, shall be deemed, as between the insured and the insurer and at all times during the negotiations…to be the agent of the insurer.’

Section 10(2) adds that ‘an insurer shall be deemed to have notice of all matters material to a contract of insurance known to [its] representative…concerned in the negotiation of the contract before the proposal of the insured is accepted by the insurer.’ 2. For the UK, the National Consumer Council Report Insurance Law Reform 1997 took the view that regulation along the lines of the Australian model is long overdue. Recommendation 2 of the Report states: ‘We recommend reform of the law on insurance to provide that: (a) intermediaries who are not registered brokers are deemed to be the agent of the insurer in any matter relating to insurance between an insured (or intending insured) consumer and the insurer; and (b) the insurer is responsible, and liable for damages, for the conduct of its agents in connection with any matter relating to insurance where — a person in the circumstances of the insured (or intending insured) could reasonably be expected to rely on the agent, and — where the insured (or intending insured) did in fact and in good faith rely on that agent.’

Legislative intervention is awaited. In the meantime it has been left to the Insurance Ombudsman to mitigate the harshness of the law. In his 1989 Report he noted that: ‘I am now prepared, in appropriate cases, to hold insurers responsible for the defaults of

intermediaries. Speculation as to exactly what will prove an appropriate case appears fruitless.’

4 The Duty of Disclosure and Misrepresentation 4.1 Utmost Good Faith Insurance is a rare species of contract where both parties, the proposer and the insurer, are under a mutual duty of utmost good faith. The insurance contract is therefore exceptional in being founded upon the doctrine of uberrimae fidei. This should be contrasted with the general common law rule that a party entering into a contract is under no duty to disclose material information: [401] Bell v Lever Bros Ltd [1932] AC 161 (HL) Lord Atkin: ‘Ordinarily the failure to disclose a material fact which might influence the mind of a prudent contractor does not give the right to avoid the contract. The principle of caveat emptor applies outside contracts of sale. There are certain contracts expressed by the law to be contracts of the utmost good faith, where material facts must be disclosed; if not, the contract is voidable. Apart from special fiduciary relationships, contracts for partnership and contracts of

insurance are the leading instances. In such cases the duty does not arise out of contract; the duty of a person proposing an insurance arises before a contract is made, so of an intending partner.’

As commented by Lord Atkin, in insurance contracts the parties are under a positive duty to disclose all material facts and breach of this duty renders the contract voidable. Thus, non-disclosure on the part of the insured entitles the insurer to avoid the contract ab initio notwithstanding the absence of any fraudulent intent. The duty therefore places a heavy burden on insureds. As such, it has proved controversial and, as we shall see, there have long been calls for reform (see, for example, the Law Commission’s Report No 104 (below, [430]) and the Report of the Sub-Committee of the British Insurance Law Association, Insurance Contract Law Reform (below, [438]). It should be borne in mind, however, that in practice the duty does not operate as harshly as might appear from its face. The Insurance Ombudsman (see the Digest, below, [423]) has done much to mitigate its force by adopting the principle of proportionality. Further, the Association of British Insurers, in return for the exemption of insurance contracts from the ambit of the Unfair Contract Terms Act 1977, issued the Statement of General Insurance Practice (1986, replacing 1977) and the Statement of Long Term Insurance Practice (1986) (below, [433] and [434]), whereby most insurers undertake to waive their strict legal rights where the policyholder

is a non-business (ie. consumer) insured (see J Birds [1970] MLR 677). We begin by looking at the early origins of the duty of utmost good faith before going on to examine its content, scope and duration (the issue of whether the duty triggers during the claims process is considered in chapter 11). Misrepresentation is considered in the second part of this chapter. Finally, we review the vexed question of reform.

4.1.1 (i) Origins of the Duty [402] Carter v Boehm (1766) 3 Burr 1905 [The insured, George Carter who was the Governor of Sumatra, effected a policy in 1759 against the risk of a French attack on Fort Marlborough. When, in fact, the fort was attacked and taken by the French the insurers rejected the insured’s claim arguing that he had failed to disclose the vulnerability of the fort and the likelihood of enemy attack. A special jury found in favour of the insured.] Lord Mansfield CJ: ‘First. Insurance is a contract upon speculation. The special facts, upon which the contingent chance is to be computed, lie most commonly in the knowledge of the insured only: the underwriter trusts to his representation, and proceeds upon confidence that he does not keep back any circumstance in his knowledge, to mislead the underwriter into a belief that the circumstance does not exist, and to induce him to estimate the risqué, as if it did not exist. The keeping back

such circumstance is a fraud, and therefore the policy is void. Although the suppression should happen through mistake, without any fraudulent intention; yet still the underwriter is deceived, and the policy is void; because the risqué run is really different from the risqué understood and intended to be run, at the time of the agreement. The policy would equally be void, against the underwriter, if he concealed; as, if he insured a ship on her voyage, which he privately knew to be arrived: and an action would lie to recover the premium…Good faith forbids either party, by concealing what he privately knows, to draw the other into a bargain, from his ignorance of that fact, and his believing the contrary. But either party may be innocently silent, as to grounds open to both, to exercise their judgment upon…This definition of concealment, restrained to the efficient motives and precise subject of any contract, will generally hold to make it void, in favour of the party misled by his ignorance of the thing concealed. There are many matters, as to which the insured may be innocently silent — he need not mention what the underwriter knows…what way soever he came to the knowledge. The insured need not mention what the underwriter ought to know; what he takes upon himself the knowledge of; or what he waves being informed of. The underwriter needs not be told what lessens the risque agreed and understood to be run by the express terms of the policy. He needs not to be told general topics of speculation: as for instance — the underwriter is bound to know every cause which may occasion natural perils…The reason of the rule which obliges parties to disclose, is to prevent fraud, and to encourage good faith. It is adapted to such facts as vary the nature of the contract; which one privately knows, and the other is ignorant of, and has no reason to suspect. The question therefore must always be “whether there was, under all the circumstances at the time the policy was underwritten, a fair representation; or a concealment; fraudulent, if designed; or, though not

designed, varying materially the object of the policy, and changing the risqué understood to be run.” The underwriter at London, in May 1760, could judge much better at the probability of the contingency, than Governor Carter could at Fort Marlborough, in September 1759. He knew the success of the operations of the war in Europe. He knew what naval force the English and French had sent to the East Indies. He knew, from a comparison of that force, whether the sea was open to any such attempt by the French. He knew, or might know everything which was known at Fort Marlborough in September 1769, of the general state of affairs in the East Indies, or the particular conditions of Fort Marlborough, by the ship which brought the orders for the insurance. He knew that ship must have brought many letters to the East India Company; and, particularly, from the governor. He knew what probability there was of the Dutch committing or having committed hostilities…’

Notes: 1. It is noteworthy that Lord Mansfield’s antecedents were Scottish, and Scottish contract law, in line with the Civilian tradition, requires good faith on the part of contracting parties. As pointed out by Lord Mustill in Pan Atlantic Insurance Co v Pine Top Insurance Co (below, [405]), Lord Mansfield was at the time attempting to introduce into English commercial law a general principle of good faith. This attempt was ultimately unsuccessful and only survived for limited classes of transactions, one of which was insurance (see also, Lord Hobhouse in The Star Sea (below, [425])). For a stimulating debate on the concept of good faith, see ADM. Forte (ed)

Good Faith in Contract and Property Law (Oxford, Hart Publishing, 1999). 2. The reason for such a wide ranging duty of disclosure was explained by Channell J in Re Yager (1912) 108 LT 28 who said that insurers are entirely dependent upon the proposer providing full disclosure of all circumstances relevant to the calculation of the risk to be underwritten and the appropriate premium to be charged. But note, Professor Hasson, in a closely reasoned essay, has argued that Lord Mansfield’s speech in Carter v Boehm has been misconstrued in subsequent cases with the result that a far stricter duty of disclosure than that originally envisaged by the Chief Justice has been erroneously fashioned by successive English judges: see R Hasson, “The Doctrine of Uberrimae Fides in Insurance Law — A Critical Evaluation” [1969] MLR 615 (below, [429]). 3. The Marine Insurance Act 1906, codifying the common law, has given statutory effect to the concept of uberrimare fides: Section 17 Insurance is uberrimae fidei A contract of marine insurance is a contract based upon the utmost good faith, and, if the utmost good faith be not observed by either party, the contract may be avoided by the other party.’

The duty has long been strictly applied to all types of insurance contracts: ‘in all cases of insurance, whether on ships, houses, or lives, the underwriter

should be informed of every material circumstance within the knowledge of the assured’: Lindenau v Desborough (1828) 8 Barn & C 586; and, more recently, it has been described as ‘an incident of the contract of insurance’ The Good Luck [1988] 1 Lloyd’s Rep 514 at 546, Hobhouse J.

4.1.2 (ii) The Content of the Duty: The Test of Materiality and the Requirement of Inducement Lord Mansfield’s formulation of the disclosure duty has been codified by section 18 of the Marine Insurance Act 1906. The law governing misrepresentation is contained in section 20 of the Act. Notwithstanding the title of the statute these provisions are of general application in insurance law. ‘Section 18 Disclosure by assured (1) Subject to the provisions of this section, the assured must disclose to the insurer, before the contract is concluded, every material circumstance which is known to the assured, and the assured is deemed to know every circumstance which, in the ordinary course of business, ought to be known by him. If the assured fails to make such disclosure, the insurer may avoid the contract. (2) Every circumstance is material which would influence the judgment of a prudent insurer in fixing the premium, or determining whether he will take the risk [emphasis added; the “prudent insurer” test was first formulated by Blackburn J in Ionides v Pender (1874) LR 9 QB 531].

(3) In the absence of inquiry the following circumstances need not be disclosed, namely: (a) Any circumstance which diminishes the risk; (b) Any circumstance which is known or presumed to be known to the insurer. The insurer is presumed to know matters of common notoriety or knowledge, and matters which an insurer in the ordinary course of his business, as such, ought to know; (c) Any circumstance as to which information is waived by the insurer; (d) Any circumstance which it is superfluous to disclose by reason of any express or implied warranty. (4) Whether any particular circumstance, which is not disclosed, be material or not is, in each case, a question of fact.’ ‘Section 20 Representations pending negotiation of contract (1) Every material representation made by the assured or his agent to the insurer during the negotiations for the contract, and before the contract is concluded, must be true. If it be untrue the insurer may avoid the contract. (2) A representation is material which would influence the judgment of a prudent insurer in fixing the premium, or determining whether he will take the risk…’

Notes: 1. As commented above, sections 17–20 of the 1906 Act codified the common law and they are of general application — there being no difference between marine and non-marine insurance in this respect: PCW Syndicates v PCW Reinsurers [1996] 1 WLR 1136, 1140. 2. To determine whether or not a non-disclosed fact is material, section 18(2) of the 1906 Act states

that it must be such as would ‘influence’ the ‘judgment’ of the prudent insurer. Although the Act does not go on to define these requirements the courts have laid down the requisite tests for determining whether they are satisfied. [403] Container Transport International Inc v Oceanus Mutual Underwriting Association (Bermuda) Ltd [1984] 1 Lloyd’s Rep 476 (CA) [The facts are immaterial]. Kerr LJ: ‘I have so far referred to non-disclosure and misrepresentation in general terms, without reference to the crucial qualification that the right to avoid a contract of insurance on these grounds arises only if the undisclosed or misrepresented circumstances are “material to the risk”, to use a common paraphrase… I…turn to what the learned Judge called the “theoretical difficulty “concerning the interpretation of section 18 (2)… The point at issue turns mainly on the meaning of “judgment” in the phrase “would influence the judgment of a prudent insurer in fixing the premium or determining whether he will take the risk”. The Judge in effect equates “judgment” with “final decision”, as though the wording of these provisions had been “would induce a prudent underwriter to fix a different premium or to decline the risk”… This interpretation differs crucially from what I have always understood to be the law and from the interpretation which Mr Evenett [an underwriter and expert witness for

Oceanus] adopted in much of his evidence. Mr Evenett interpreted section 18 (2) in the sense that “judgment” referred to the assessment or evaluation of the risk…In my view this is the correct approach, and I would expect everyone experienced in the market to reply in this sense, whether underwriter or broker… The duty of disclosure, as defined or circumscribed by [by the 1906 Act], is one aspect of the overriding duty of the utmost good faith mentioned in section 17. The actual insurer is thereby entitled to the disclosure to him of every fact which would influence the judgment of a prudent insurer in fixing the premium or determining whether he will take the risk. The latter words, as Mr Evans rightly said, must comprise any terms, and not only the level of premium, which an insurer might require in the wording of the cover, eg warranties, franchises, deductibles, exceptions, etc. The word “judgment” — to quote the Oxford English Dictionary to which we were referred — is used in the sense of “the formation of an opinion”. To prove the materiality of an undisclosed circumstance, the insurer must satisfy the Court on a balance of probability — by evidence or from the nature of the undisclosed circumstance itself — that the judgment, in this sense, of a prudent insurer would have been influenced if the circumstance in question had been disclosed. The word “influenced” means that the disclosure is one which would have had an impact on the formation of his opinion and on his decision-making process in relation to the matters covered by section 18 (2). One must bear in mind that the issue is as to the relevance, and not as to the weight, of any evidence which may be adduced in order to show that an undisclosed circumstance was material. Such evidence may be given by the actual insurer who — ex hypothesi — has accepted the risk in ignorance of the undisclosed fact. For him, it may be relatively easy to say simply: “Had I known this, I would have declined the risk, or imposed such-and-such a term, or

charged such-and-such a premium”. But this is not the nature of the evidence to which section 18 (2) is directed; nor is such evidence required from any witness who may be called on the question of materiality. The section is directed to what would have been the impact of the disclosure on the judgment of the risk formed by a hypothetical prudent insurer in the ordinary course of business…He is in a hypothetical position, and evidence to support the materiality of the undisclosed circumstance, from this point of view, is therefore often given by an independent expert witness whose evidence has to be assessed by the Court long after the event… The weight which the Court would give to such evidence is then a matter for the Court… …It follows that when [the relevant provisions of the 1906 Act] are read together, one way of formulating the test as to the duty of disclosure and representation to cases such as the present…is simply to ask oneself: “Having regard to all the circumstances known or deemed to be known to the insured and to his broker, and ignoring those which are expressly excepted from the duty of disclosure, was the presentation in summary form to the underwriter a fair and substantially accurate presentation of the risk proposed for insurance, so that a prudent insurer could form a proper judgment — either on the presentation alone or by asking questions if he was sufficiently put on enquiry and wanted to know further details — whether or not to accept the proposal, and, if so, on what terms?” This is not an onerous duty for brokers to discharge in practice. Nor was it at all difficult in the present case.’

Note: The decision in CTI generated considerable criticism particularly against the burden it places on the insured: see Henry Brooke QC, “Materiality in

insurance contracts” [1985] LMCLQ 437; Adrian Hamilton QC, “Avoidance of liability on the grounds of misrepresentation and non-disclosure, or, the rise and rise of avoidable reinsurance,” Insurance and Reinsurance Law, September 1985, p 131; Anthony Diamond QC, “The law of marine insurance — has it a future?” [1986] LMCLQ 25; Steyn J, “The Role of Good Faith and Fair Dealing in Contract Law: A Hairshirt Philosophy?” [1991] Denning LJ 131, 138–140; and Howard .N Bennett, “The Duty to Disclose in Insurance Law” [1993] LQR 513. [404] Malcolm Clarke, “Failure to Disclose and Failure to Legislate: Is it Material? — II” [1988] JBL 298 ‘Materiality; the degree of influence The proposer must disclose what he knows or can be assumed to know…which is material to the risk. What is material is decided by reference to the judgment of the prudent underwriter. Some facts are more important than others and there remains this question: how great must be the potential influence on the assessment of risk of the undisclosed fact, if the insurer is to be allowed to avoid the contract?

The three degrees of influence Section 18(2) of the Marine Insurance Act 1906 provides that a fact is material if it “would influence the judgment of a prudent insurer in fixing the premium, or determining whether he will take the risk.” This rule. applies also to nonmarine insurance and although the proposals of the Law Commission were not addressed to marine insurance, there is little doubt that when the courts pronounce on disclosure

of hull risks, there are repercussions for householders. The reference in section 18(1) to influence does not tell us the degree of influence that is required. There are broadly speaking three possibilities: (A) Information type A is so material that, if the insurer had known it, he would have refused to make the contract at all, or he would have responded by further investigation leading to refusal. This is the degree of influence required in certain jurisdictions’ of the United States, if the insurer is to rescind. In a recent decision [Knight v US Fire Insurance Co 651 F Supp 471 (SD NY 1986)] the Federal District Court of New York said that materiality in this context depends on whether the information is “something which would have controlled the underwriters’ decision to take on the risk”… (B) Information type B is such that, if the insurer had known of it, he would still have made the contract of insurance but only on terms, especially as to premium, different from those he did make, or he would have responded with further investigation leading to insurance on different terms. Some support for this view can be found in England in early cases. More recent support is found in [Berger Ltd v Pollock [1973] 2 Lloyd’s Rep 442, 463] where the nondisclosure of certain information, was held immaterial because the judge was “far from satisfied that, if the undisclosed matters had been fully reported and explained to these underwriters, they would in fact have declined to accept this declaration under open cover or have sought to vary its terms or to require an increased rate of premium.” The judge, however, was Kerr J (as he then was), who later took a different view in CTI v Oceanus [above, 4.3]… (C) Information type C is such that, if the insurer had known of it, he would have considered it relevant but

not so material that he would have refused the contract or insisted on different terms. It would have “affected” his judgment perhaps by reinforcing it — it was information which, together with other facts, had they been present, would have produced a different contract, but, considered alone, made no difference to the particular contract or its terms. As a result of the judgments of the Court of Appeal in CTI v Oceanus, this is the current rule in England. It has been suggested that this case moves English law in the direction proposed by the Law Commission. It is very doubtful that the Court of Appeal thought it was moving the law at all; on tire contrary, one of the bases of the decision was a desire to respect the Court’s view of precedent. In reality it will be contended that the Court has moved the law away from precedent, away from principle and, if the Law Commission was indeed concerned, as it appears, to protect the assured, away from the interests of the assured… There are a number of reasons for thinking that [CTI]… moves in the wrong direction. Precedent. In CTI v Oceanus the Court of Appeal considered its opinion to be in accord with precedent. About this there must be doubt. In the beginning there was Lord Mansfield who would not lightly set a contract aside for nondisclosure: “Although the suppression should happen through mistake, without any fraudulent intention; yet still the underwriter is deceived, and the policy is void; because the risk run is really different from the risk understood, and intended to be run, at the time of the agreement.”

It is submitted that most of the early cases, some of which seemed to influence the Court of Appeal, can be distinguished on one or more of the following grounds: (a) The cases did not concern information type C, and therefore the decision in those cases did not concern the materiality of such information. (b) The materiality of the information was admitted and thus not the subject of searching debate by the court. (c) The cases concerned fraud, to which courts have usually responded with a rule more favourable to the insurer. Other cases, previously considered leading cases on materiality, were distinguished by the Court of Appeal… [In]…Zurich General Accident & Liability Insurance Co. Ltd. v Morrison [1942] 2 KB 53…the issue was whether a judgment obtained against the assured by the victim of a motor accident could be enforced against the insurer under the Road Traffic Act 1934, section10. The insurer pleaded non-disclosure that the assured had failed the driving test. The Court of Appeal rejected this defence. Lord Greene MR, said: “The evidence entirely fails to convince me insurers, had they known of the failure to pass would have declined to issue a policy on precisely terms as those on which they did issue the question.”

that the the test, the same policy in

In CTI v Oceanus Kerr LJ distinguished the Morrison case as turning on the particular statute; in a sense this is right, but in a sense it is not. For a plea of non-disclosure the statute required not one thing but two: not only objective materiality (potential influence), but also subjective materiality (actual influence). In Oceanus there was one hurdle and in Morrison there were two; but the first hurdle in each case, that of objective materiality, was the same. On

that question Morrison was and is good precedent in England. Practicality. “It is possible to say that prudent underwriters in general would consider a particular circumstance as bearing on the risk and exercising an influence on their judgment towards declining the risk or loading the premium. It is not possible to say, save in extreme cases, that prudent underwriters in general would have acted differently, because there is no absolute standard by which they would have acted in the first place or as to, the precise weight they would give to the undisclosed circumstance.” This opinion from Parker LJ in CTI v Oceanus is open to a number of objections. First, although there is no “absolute standard”, (a loaded phrase), the test of materiality is that of the prudent insurer, an objective test controlled and applied by the court in the light of expert evidence, like that of the reasonable man in tort. To broke a risk it may be necessary in practice to broke the personality, that is, to take account of the views of the particular underwriter; but it is another matter to accommodate marginal views of possibly nervous underwriters by having a rule of law which allows such people to upset important contracts. In the context of insurance practice the test of the prudent insurer is no more a genuine inquiry into the mind of a particular person than it is in relation to the other reasonable or prudent persons who populate the rules of law to legitimise the dominant role of the judge. Secondly, given the objective nature of the materiality test, it is not obvious why it is easier (and thus more practical and more certain) to say that a fact has some influence

(type C) than to say that it has a decisive influence (type A or type B). Thirdly, if the proposer must disclose information type C, there is the further objection that potential assureds wilI be advised to play safe by total disclosure. Over 100 years ago Blackburn J said’s that “it would be too much to put on the assured the duty of disclosing everything which might influence the mind of an underwriter. Business could hardly be carried on if this was required”[Ionides v Pender [(1874) LR 9 QB 531]. The traditional London practice of rapid placement of risks would be blocked by an avalanche of information. The placing file in CTI v Oceanus itself was over 100 pages in length; yet the Court of Appeal held that the insurer had not been told enough! The relentless march of the megabyte, of the machine that copies, stores and faxes to foreign parts, may be such that it is now too late. Principle. In the general law contracts can be ended or avoided, but only if something goes seriously wrong. In recent years the trend of the law has been to make it not easier but harder to end contracts. A contract can be terminated for breach of contract only if the breach is serious or if the contract itself provides for termination in very clear terms.” Since 1967 the right to rescind a contract for misrepresentation is only absolute, ie free of court discretion to refuse rescission, in cases of fraud [the Misrepresentation Act 1967, section 2(2)]. In tort no action for damages will lie in respect of negligent mis-statement, unless that statement contained material information of type A or B. In Jeb Fasteners Ltd. v Marks Bloom & Co. Donaldson LJ thought immaterial all information which “will not affect the essential validity of [the] decision in the sense that if the truth had been known or suspected before the decision was taken, the same decision would still have been made.” In other words the act

impugned must be in some sense a cause of the loss or damage. Last but not least the decision in CTI v Oceanus ignores the basic nature of misrepresentation and non-disclosure as something that vitiates consent, here the consent of the insurer. How can it be said that the consent of the insurer is vitiated, and that the contract should therefore be avoided, if he would have made the same contract on the same terms, even if there had been no misrepresentation or no non-disclosure?…’

Notes: 1. The rejection of the “decisive influence test” by the Court of Appeal in CTI was followed by the House of Lords in Pan Atlantic (below, [405]). However, the majority of their Lordships thought that the harshness of the duty of disclosure, together with the criticisms launched against the CTI decision, could be addressed by assimilating non-disclosure with misrepresentation. It was therefore held that the non-disclosure of a material fact must induce the underwriter to enter into the insurance contract and that inducement was to be presumed. The question of how ignorance of a material fact could operate as an inducement to contract was not addressed. 2. In a powerful dissent, Lord Lloyd reasoned that for the purposes of section 18 of the 1906 Act, “influence” on the prudent insurer’s judgement should be determined by reference to whether or not such influence had a decisive effect in moving the underwriter to accept the risk.

[405] Pan Atlantic Insurance Co Ltd v Pine Top Insurance Co [1995] 1 AC 501 (HL) [The facts are immaterial]. Lord Goff: ‘Underlying the appeal before your Lordships’ House have been two questions of principle, of great importance to the law of insurance. The first relates to the test of materiality in cases of non-disclosure, which in the law of marine insurance is to be found in section 18(2) of the Marine Insurance Act 1906… Here the question for your Lordships is whether, as the appellant plaintiffs (“Pan Atlantic”) have contended, it must be shown that full and accurate disclosure would have led the prudent insurer either to reject the risk or at least to have accepted it on more onerous terms. This has been called the “decisive influence test.” The second question is whether, for an insurer to be entitled to avoid a policy for misrepresentation or non-disclosure, it is enough that the misrepresentation or non-disclosure was material, or whether in addition it must, as Pan Atlantic have contended, have induced the making of the policy on the relevant terms. This has been called the “actual inducement test.” I turn first to the second of these questions. Like both of my noble and learned friends [Lord Mustill and Lord Lloyd], I have come to the conclusion that, on this question, Mr Beloff’s submission on behalf of Pan Atlantic should be accepted; in other words, I accept that the actual inducement test accurately represents the law. I do so for the reasons given by my noble and learned friend, Lord Mustill. Like him, and for the reasons he gives, I conclude that there is to be implied in the Act of 1906 a requirement that a material misrepresentation will only entitle the insurer to avoid the policy if it induced the making of the contract; and that a similar conclusion must be reached in

the case of a material non-disclosure. This conclusion is, as I understand it, consistent with the opinion expressed by my noble and learned friend, Lord Lloyd, that Parliament, by enacting the law as it did in…1906, must have intended to codify the common law on materiality without touching the common law on inducement. I turn next to the first question, which is whether the decisive influence test is the appropriate test for deciding whether a fact which has not been disclosed is a material fact. Here there is a difference of opinion between my two noble and learned friends, Lord Lloyd accepting the decisive influence test and Lord Mustill rejecting it. On this point, I respectfully prefer the reasoning of Lord Mustill…’

Lord Mustill: ‘MATERIALITY This part of the case depends on the words “which would influence the judgment of a prudent insurer in fixing the premium, or determining whether he will take the risk.” The main thrust of the argument for Pan Atlantic is that this expression calls for the disclosure only of such circumstances as would, if disclosed to the hypothetical prudent underwriter, have caused him to decline the risk or charge an increased premium. I am unable to accept this argument. In the first place I cannot find the suggested meaning in the words of the Act. This is a short point of interpretation, and does not yield to long discussion. For my part I entirely accept that part of the argument for Pan Atlantic which fastens on the word “would” and contrasts it with words such as “might.” I agree that this word looks to a consequence which, within the area of uncertainty created by the civil standard of proof, is definite rather than speculative. But this is only part of the inquiry. The next step is to decide what kind of effect the disclosure would have.

This is defined by the expression “influence the judgment of a prudent insurer.” The legislature might here have said “decisively influence,” or “conclusively influence,” or “determine the decision,” or all sorts of similar expressions, in which case Pan Atlantic’s argument would be right. But the legislature has not done this, and has instead left the word “influence” unadorned. It therefore bears its ordinary meaning, which is not, as it seems to me, the one for which Pan Atlantic contends. “Influence the judgment” is not the same as “change the mind.” Furthermore, if the argument is pursued via a purely verbal analysis, it should be observed that the expression used is “influence the judgment of a prudent insurer in determining whether he will take the risk.” To my mind, this expression clearly denotes an effect on the thought processes of the insurer in weighing up the risk, quite different from words which might have been used but were not, such as “influencing the insurer to take the risk.”… [T]he point is that it is not the court after the event, but the prospective assured and his broker before the event, at whom the test is aimed; it is they who have to decide, before the underwriter has agreed to write the risk, what material they must disclose. I am bound to say that in all but the most obvious cases the “decisive influence” test faces them with an almost impossible task. How can they tell whether the proper disclosure would turn the scale? By contrast, if all that they have to consider is whether the materials are such that a prudent underwriter would take them into account, the test is perfectly workable. Furthermore, the argument for Pan Atlantic demands an assumption that the prudent underwriter would have written the risk at the premium actually agreed on the basis of the disclosure which was actually made. Yet this assumption is impossible if the actual underwriter, through laziness, incompetence or a simple error of judgment, has made a bargain which no prudent underwriter would have made, full

disclosure or no full disclosure. This absurdity does not arise if the duty of disclosure embraces all materials which would enter into the making of the hypothetical decision, since this does not require the bargain actually made to be taken as the starting point…Accordingly, treating the matter simply as one of statutory interpretation I would feel little hesitation in rejecting the test of decisive influence… INDUCEMENT I turn to the second question which concerns the need, or otherwise, for a causal connection between the misrepresentation or non-disclosure and the making of the contract of insurance. According to sections 17, 18(1) and 20(1) if good faith is not observed, proper disclosure is not made or material facts are misrepresented, the other party, or in the case of sections 18 and 20 the insurer, “may avoid the contract.” There is no mention of a connection between the wrongful dealing and the writing of the risk. But for this feature I doubt whether it would nowadays occur to anyone that it would be possible for the underwriter to escape liability even if the matter complained of had no effect on his processes of thought. Take the case of misrepresentation. In the general law it is beyond doubt that even a fraudulent misrepresentation must be shown to have induced the contract before the promisor has a right to avoid, although the task of proof may be made more easy by a presumption of inducement. The case of innocent misrepresentation should surely be a fortiori, and yet it is urged that so long as the representation is material no inducement need be shown. True, the inequalities of knowledge between assured and underwriter have led to the creation of a special duty to make accurate disclosure of sufficient facts to restore the balance and remedy the injustice of holding the underwriter to a speculation which he had been unable fairly to assess; but this consideration cannot in logic or justice require courts to go further and

declare the contract to be vitiated when the underwriter, having paid no attention to the matters not properly stated and disclosed, has suffered no injustice thereby… My Lords, in my judgment little or nothing can be gleaned from the twentieth century cases to indicate a solution to the problem of causation. Before stating my own opinion on this problem there are two more points to be made. First, one suggested explanation for the absence from section 20 of any requirement that the misrepresentation shall have induced the contract is that any such requirement had been swept away 30 years before in Ionides v Pender…However, as I have said, although Ionides v Pender was an important case it did not in my opinion have the effect contended for. Secondly, it has been suggested that the absence from the Act of any reference to causation stems from a disciplinary element in the law of marine insurance. The concept is that persons seeking insurance and their brokers cannot be relied upon to perform their duties spontaneously; that the criterion of whether or not the misrepresentation or non-disclosure induced the contract would make it too easy for the assured to say that the breach of duty made no difference; and that accordingly the law prescribes voidability as an automatic consequence of a breach by way of sanction for the enforcement of full and accurate disclosure. For my part, although I think it possible to detect traces of this doctrine in the earlier writings I can see nothing to support it in later sources; and I would unhesitatingly reject any suggestion that it should now be made part of the law. The existing rules, coupled with a presumption of inducement, are already stern enough, and to enable an underwriter to escape liability when he has suffered no harm would be positively unjust, and contrary to the spirit of mutual good faith recognised by section 17, the more so since non-disclosure will in a substantial proportion of cases be the result of an innocent mistake.

For these reasons I conclude that there is to be implied in the Act of 1906 a qualification that a material misrepresentation will not entitle the underwriter to avoid the policy unless the misrepresentation induced the making of the contract, using “induced” in the sense in which it is used in the general law of contract. This proposition is concerned only with material misrepresentations. On the view which I have formed of the present facts the effect of an immaterial misrepresentation does not arise and I say nothing about it. There remain two problems of real substance. The first is whether the conclusion just expressed can be transferred to the case of wrongful non-disclosure. It must be accepted at once that the route via…the general common law which leads to a solution for misrepresentation is not available here, since there was and is no general common law of nondisclosure. Nor does the complex interaction between fraud and materiality, which makes the old insurance law on misrepresentation so hard to decipher, exist in respect of non-disclosure. Nevertheless if one looks at the problem in the round, and asks whether it is a tolerable result that the Act accommodates in section 20(1) a requirement that the misrepresentation shall have induced the contract, and yet no such requirement can be accommodated in section 18(1), the answer must surely be that it is not — the more so since in practice the line between misrepresentation and non-disclosure is often imperceptible. If the Act, which did not set out to be a complete codification of existing law, will yield to qualification in one case surely it must in common sense do so in the other. If this requires the making of new law, so be it. There is no subversion here of established precedent. It is only in recent years that the problem has been squarely faced. Facing it now, I believe that to do justice a need for inducement can and should be implied into the Act…I believe that both principle and justice require the conclusion which I have expressed…

Finally, there is the question whether this conclusion holds good for non-marine insurance. The problems raised by the wording of sections 18(1) and 20(1) do not here arise. The general considerations are however the same, and I feel no doubt that they should lead to the same conclusion. Before embarking on this long analysis I suggested that the questions in issue were short. I propose the following short answers. (1) A circumstance may be material even though a full and accurate disclosure of it would not in itself have had a decisive effect on the prudent underwriter’s decision whether to accept the risk and if so at what premium. But, (2) if the misrepresentation or non-disclosure of a material fact did not in fact induce the making of the contract (in the sense in which that expression is used in the general law of misrepresentation) the underwriter is not entitled to rely on it as a ground for avoiding the contract. These propositions do not go as far as several critics of the CTI case would wish, but they maintain the integrity of the principle that insurance requires the utmost good faith, whilst avoiding the consequences, to my mind unacceptable, of upholding Pine Top’s arguments in full.’

Lord Lloyd (dissenting): ‘[T]he duty to disclose every material circumstance known to the assured before a contract of insurance is concluded… is closely linked with the duty to ensure that every material representation is true…Both are illustrations or consequences of the rule, set out in section 17, that a contract of insurance is a contract of utmost good faith. In practice, non-disclosure and misrepresentation are often joined as defences in the same pleading. They were joined in the CTI case and so they are here. Often, as here, the alleged misrepresentation adds nothing. It is but the converse of the non-disclosure (“impliedly represented that [the proffered] information…gave a true and fair picture”)…

[W]hereas the right to avoid for non-disclosure is peculiar to contracts of utmost good faith, the right to avoid for misrepresentation is part of the general law of contract. The reason for the special rule relating to non-disclosure in insurance contracts is that in the usual case it is the assured alone who knows “the special facts, upon which the contingent chance is to be computed:” see Carter v Boehm, per Lord Mansfield…The purpose of the rule is to rectify that imbalance. But in the case of misrepresentation there is no need to differentiate between a contract of insurance and any other contract. There is no reason to put the insurer in a more favourable position than other contracting parties, and no justification for doing so. The ordinary law suffices. Lastly, the duty of disclosure operates both ways. Although, in the usual case, it is the assured who knows everything, and the insurer who knows nothing, there may be special facts within the knowledge of the insurer which it is his duty to disclose, as where (to take the example given by Lord Mansfield in Carter v Boehm) the insurer knows at the time of entering into the contract that the vessel has already arrived. Thus the obligation of utmost good faith is reciprocal…Nor is the obligation of good faith limited to one of disclosure. As Lord Mansfield warned in Carter v Boehm, there may be circumstances in which an insurer, by asserting a right to avoid for non-disclosure, would himself be guilty of want of utmost good faith. THE PRUDENT INSURER …Mr Beloff’s criticism of the CTI test can be encapsulated in a series of rhetorical questions. If the prudent insurer, knowing of the undisclosed fact, would have accepted the risk at the same premium and on the same terms, what right has the actual insurer to complain? What injustice has he suffered? If the risk run is different from the risk understood or intended to be run, then, as Lord Mansfield made plain in Carter v Boehm, the insurer can avoid; and

rightly so. But if the prudent insurer would have accepted the risk at the same premium and on the same terms, it must be because, so far as he is concerned, the risk is the same risk. How, as a matter of ordinary language, can a circumstance be described as material when it would not have mattered to the prudent insurer whether the circumstance was disclosed or not? It is obvious that the insurer cannot be required to disclose every circumstance, however remotely related to the assessment of the risk. Why then should he be required to disclose a circumstance which would not in fact have made any difference? How in those circumstances could it be said that the actual insurer’s consent had been vitiated? and if not, on what other juristic basis could he claim the right to avoid the contract? Mr Hamilton’s answer to this line of criticism was that it is the insurer who is entitled to decide whether to accept the risk or not, and if so at what premium. So it is for the assured to disclose everything which the insurer would want to know, or would take into account, in reaching that decision. I do not find this answer satisfactory, not because, as is sometimes said, it makes the insurer judge in his own cause, but rather because it blurs the edges of the prudent insurer test. The purpose of the test…was to establish an objective test of materiality, not dependent on the actual insurer’s own subjective views. The test should therefore be clear and simple. A test which depends on what a prudent insurer would have done satisfies this requirement. But a test which depends, not on what a prudent insurer would have done, but on what he would have wanted to know, or taken into account, in deciding what to do, involves an unnecessary step. It introduces a complication which is not only undesirable in itself but is also, in the case of inadvertent non-disclosure, capable of producing great injustice…

That brings me to the central question. What does section 18(2) of the Act of 1906 mean? In particular, what is meant by the words “would influence the judgment of a prudent insurer?” If I ask myself what the phrase as a whole means, I would answer that it points to something more than what the prudent insurer would want to know, or take into account. At the very least it points to what the prudent insurer would perceive as increasing, or tending to increase, the risk… The ordinary meaning of “influence” is to affect or alter. “Judgment” is a word with a number of different meanings, so it is not possible to identify the ordinary meaning in the abstract. In a legal or quasi- legal context it is often used in the sense of a decision or determination, as in “the judgment of Solomon” or “the judgment of Paris,” or the formal judgment of a court of law. Kerr LJ in the CTI case considered that it meant not the decision itself, but what he called the decision-making process. I accept that the word may bear that meaning. But it is not the primary meaning given in the Oxford English Dictionary, as Kerr LJ’s judgment may suggest, and I see no reason to give it that meaning in the present context. In a commercial context “judgment” is often used in the sense of “assessment.” A market assessment means a judgment as to what the market is going to do, not the process by which a stockbroker arrives at that judgment. That is, in my opinion, the sense in which the word is used in section 18(2) of the Act of 1906… Finally, there is the word “would.” Kerr LJ in the CTI case, at p 492…refers to things which the insurer might have done if he had been told of the undisclosed fact. In my judgment it is never enough to show that a prudent insurer might have declined the risk or charged an increased premium. It is necessary to show that he would have done. My provisional conclusion…is that Mr Beloff succeeds on the first half of his argument, and that in order to avoid a

contract for non-disclosure it must be shown that a prudent insurer, if he had known of the undisclosed fact, would either have declined the risk altogether, or charged an increased premium…My reasons for preferring Mr Beloff’s test are that it does full justice to the language of section 18 of the Act of 1906. It is well-defined, and easily applied. It does something to mitigate the harshness of the all-ornothing approach which disfigures this branch of the law, and it is consistent with the reasons given by the Court of Appeal for rejecting the test proposed by Mr Hamilton…’

Notes: 1. See J Birds and N Hird, “Misrepresentation and non-disclosure in insurance law — identical twins or separate issues” [1996] MLR 285. 2. The Court of Appeal in the St Paul’s Fire and Marine Insurance Co v McConnell Dowell Constructors Ltd [1995] 2 Lloyd’s Rep 116 held that the test for materiality had been settled by the House of Lords in Pan Atlantic — the insured was under a duty to disclose what the insurer would have wished to know. As regards the question of inducement, it was held that the non-disclosed fact need not be the sole inducement, it need only be demonstrated that it was an inducement. This accords with the position in the general law of contract: Edgington v Fitzmaurice (1885) 19 Ch D 459, Bowen LJ). [406] Norma J Hird, “Pan Atlantic — Yet More to Disclose” [1995] JBL 608

‘…We have recently had the first appellate court decision since Pan Atlantic: in St Paul Fire and Marine Co (UK) Ltd v McConnell Dowell Constructors Ltd, the Court of Appeal was asked to clarify certain issues arising out of the Pan Atlantic judgment. The facts of St Paul McConnell Dowell were the contractors for the construction of certain buildings in the Marshall Islands. Their client was the government of that territory and the project comprised the Parliament building and an administration block on Majuro Atoll. In 1982, the government commissioned a report from Geo-Engineering and Testing Inc, (GET), which recommended that piled, rather than shallow spread, foundations should be used in the construction project. MD were instructed to proceed with phase 1 of the project in 1989, and therefore instructed a New Zealand based broker to obtain quotations for Contractors’ All Risks insurance. An architect’s report at this time, however, (unknown to the brokers), concluded that the GET report had underestimated the stability of shallow spread foundations, and that it was unnecessary to incur the extra expense of piled foundations. The brokers obtained quotations based on the use of piled foundations, and eventually, in early 1990, placed the cover with St Paul, and three other insurers. Construction commenced, using shallow spread foundations, and, by the end of 1990, the Parliament building was discovered to be suffering serious subsidence problems. St Paul sought to avoid the contract of insurance on the grounds of misrepresentation — the policy made no actual reference to the foundations which were to be used, and it was accepted that the misrepresentation was entirely inadvertent… The decision a) Materiality

…In the course of his judgment, Evans LJ discussed, at some length, the reasoning of the majority of the House of Lords in Pan Atlantic, particularly the leading speech by Lord Mustill, which was endorsed by Lord Goff. He considers that Lord Mustill was quite definite in his determination of the test for materiality, quoting particularly: “I can see nothing in them [authorities and textbooks] to suggest that before 1906 materiality was understood as extending only to such circumstances as would definitely have changed the underwriter’s mind; and they furnish substantial support for the view that the duty of disclosure extended to all matters which would have been taken into account by the underwriter when assessing the risk (ie the “speculation”) which he was consenting to assume. This is, in my opinion, what the Act was intending to convey, and what it actually says.” This does appear to be quite definite, and an appeal by McConnell Dowell on this point, at least to this writer, always appeared futile. Evans LJ goes on to say however, “This concept, in my judgment, is no different from the formulation in Steyn LJ’s judgment (“would have appreciated that it was a different risk”). To this extent, Lord Mustill expressly approved the Court of Appeal’s definition…” This statement, is, I think, worthy of some consideration. It surely must be argued that Lord Mustill neither intended, nor did, in fact, approve the CA’s definition of materiality. If materiality is determined only by a reference to something which might be of interest to a prudent insurer, this does not come close to a test which defines materiality in terms of an appreciated “increased risk”. The fact may be of interest to a prudent insurer, and it may, indeed, increase the risk, but, according to the House of Lords, only the first

of these need be shown — no reason as to why it is of interest need be given and, therefore, the second must be regarded as being irrelevant. That Lord Mustill did not support the CA’s test is further borne out by remarks which he made on its judgment earlier in his own: “In the Court of Appeal, we find the court striving, through the medium of the principal judgment delivered by Steyn LJ, to find a workable understanding of the ratio of the CTI case which was consistent not only with the rejection of decisive influence as the test for materiality but also with the rejection of any requirement of influence on the actions of the individual underwriter. It may well be that but for this second constraint the court might have felt more free in its ruling on materiality.” Lord Mustill is undoubtedly correct in his conclusion on that judgment. All three members of the Court of Appeal were unhappy with the result in Pan Atlantic, and clearly felt the need to establish a narrow test for materiality, in the interests of fairness and justice. It has already been argued elsewhere [1995 JBL 194] that had the court not rejected the decisive influence test, then there would have been no need for such artificial “striving”. Lord Mustill, on behalf of the majority of the House, also went on to reject it; therefore he, in the interests of fairness and justice, was forced to introduce a completely novel concept of inducement into the law of utmost good faith. He then, of course, was not constrained when ruling on materiality, and it appears quite clear from his judgment that he was in no doubt that the proper test for materiality should be the much broader based test of “interest”, rather than “increased risk”. This left Evans LJ, in St Paul with something of a dilemma, and we see signs of that same artificial striving, referred to above, as he struggles to reconcile the various pronouncements in various courts on this issue. His final

conclusion is yet more interesting. He says, “once the question of inducement is removed from the definition of materiality, therefore, it may be that in practical terms there is little difference between the decisive influence test and the correct test, expressed in terms of the prudent underwriter’s estimate of the risk.” This is undoubtedly correct, if he means inducement in the strict sense, but surely the whole point here is that the definition of materiality expressed in the MIA impliedly carries within it the essential concept of a causal link between the misrepresented or undisclosed facts, and the insurer’s right to avoid because of loss, but, it is the prudent insurer we are here concerned with, not the actual insurer. The courts’ stubborn refusal to accept the decisive influence test as the correct test for materiality appears therefore to be somewhat mystifying. All previous case law authority points this way; even those insurance law cases where judges speak of materiality and inducement as separate issues, it is plain from their language that they are not referring to inducement in the strict sense that the HL spoke of it in Pan Atlantic, but rather as it being a concept that does not allow an underwriter to avoid the policy if he has suffered no loss. Equally, there is no mention of inducement in the Marine Insurance Act. The current courts’ insistence on separating the prudent insurer from the actual insurer is what is causing the problem, and this insistence is both unnecessary, and unfair…To introduce the actual insurer into the equation simply lays an extra burden onto the insured, because it opens the door to an insurer to state that, regardless of the fact that the undisclosed material may not have induced the prudent insurer into the contract, it nevertheless induced him, the actual insurer, with all of his particular idiosyncrasies. In the light of this, it must be said again that the sensible, fair test for materiality must be considered to be the “decisive influence” test so firmly rejected by almost

everyone, and further, if we accept that the aim of the HL in Pan Atlantic, and the CA in St Paul was to clarify the law on this issue, then we must conclude that, despite a valiant attempt, both have failed to do so. The introduction of an inducement requirement of the actual insurer has served only to muddy further far from clear waters.

b) Inducement In St Paul, it was common ground between the parties that, following Pan Atlantic, inducement on the part of the actual underwriter must now be proved, but, again, there were unresolved issues. These were (i) did the underwriter benefit from a presumption of inducement? and (ii) did the misrepresented or undisclosed fact have to be shown to be the inducement, rather than merely an inducement? If the proper test for materiality is the very broad one based on “interest”, then, if inducement is to aid the insured in any meaningful way, the first of these must be discounted, and the second vigorously supported. Alas, exactly the opposite was decided by the CA in St Paul. A presumption of inducement was supported by Lord Mustill in Pan Atlantic, but denied by Lord Lloyd. In St Paul, three of the underwriters produced evidence of inducement, but one failed to do so; the resolution of this issue therefore became crucial. The CA held that a presumption of inducement in favour of the insurer did, indeed, exist; we must therefore assume that it is so strong that an insurer can rely upon it without adducing evidence. This is a regrettable state of affairs, and highlights the difficulties discussed above, of introducing the actual insurer into the picture. It is made even worse by further pronouncements which state that it is not necessary for the insurer to show that the undisclosed or misrepresented facts were the only inducement, but only that they were a possible, (not even probable), cause of his acting the way he did. Any

safeguards which the House of Lords intended to introduce for insureds are now, clearly, redundant. It has been stated that following the Court of Appeal’s decision in St Paul, the law on utmost good faith in insurance has not changed in any meaningful way. It is arguable that it has changed, and not for the better. Before Pan Atlantic it was at least still open to the insured to argue that contained within the definition of materiality was the need for a causal link between the misrepresented or undisclosed fact, and the remedy of avoidance for loss — this door has now been closed, and if the recent pronouncements on inducement are considered correct, and are followed, then the law is even more prejudiced in favour of the insurer…’

Note: The extent of the inducement requirement thus continues to be somewhat uncertain. In Marc Rich & Co AG v Portman [1996] 1 Lloyd’s Rep 430 (decided before St Paul Fire), Longmore J narrowed the scope of inducement so that it would only trigger where the insurers were unable, with good reason, to give evidence. He said: ‘Mr Kealey [counsel for the claimants] submitted that Mr Overton had so little understanding of the risk that he was writing that it would have made no difference to him if he had been told, at the time when he initialled the endorsements, about the matters now said not to have been disclosed… Mr Kealey [citing Lord Mustill’s speech in Pan Atlantic] submitted that this presumption is much diminished if it can be shown that the actual underwriter was careless in the writing of the very risk itself…In most cases in which the actual underwriter is called to give evidence and is cross-

examined, the Court will be able to make up its own mind on the question of inducement. The presumption will only come into play in those cases in which the underwriter cannot (for good reason) be called to give evidence and there is no reason to suppose that the actual underwriter acted other than prudently in writing the risk. In cases where he is called and the Court genuinely cannot make up its mind on the question of inducement, the insurer’s defence of nondisclosure should fail because he will not have been able to show that he had been induced by the non-disclosure to enter into the insurance on the relevant terms. At the end of the day it is for the insurer to prove that the non-disclosure did induce the writing of the risk on the terms in which it was written.’

The Court of Appeal (reported at [1997] 1 Lloyd’s Rep 225), affirmed the decision but did not take the opportunity to give a detailed consideration of the point. Leggatt LJ merely observed that he could ‘see no warrant for interfering with [the trial judge’s] conclusion.’ In the ICCI decision (below, [407]) the presumption operated in favour of the insurers notwithstanding that they did not give direct evidence to substantiate inducement. [407] Insurance Corporation of the Channel Islands v Royal Hotel Ltd [1998] Lloyd’s Rep I R 151 [The insured, a hotel owner, falsified the hotel’s occupancy rates in order to inflate the sums that would be payable under the policy’s business

interruption cover. In 1992 the hotel was closed as a result of a series of fires]. Mance J: ‘Looking at all the material before me, I am satisfied that all the underwriting personnel within ICCI and Mr Walpole as its managing director would have taken a serious view of Royal Hotel’s conduct, and that ICCI would have been unlikely to offer renewal if it had known of such conduct before renewal. I accept that the matter would have been likely to reach Mr Walpole’s attention. He was and is clearly the dominant character within ICCI…his primary role over the last 14 years has been in management and administration. In that role he would naturally be concerned about the quality of the ICCI’s portfolio…I consider that Mr Walpole was and is someone who would, if he had known of conduct such as the Royal Hotel’s conduct…have adopted and applied the general attitude…of not knowingly insuring a person whom he believed to be dishonest and of refusing renewal accordingly. I also consider that this is the attitude which any reputable and experienced insurer (like the present insurers) would have been likely to adopt in the face of dishonest conduct such as Royal Hotel’s here. I therefore find that ICCI was induced to underwrite the… policy in October 1991 by non-disclosure of Royal Hotel’s conduct…’

See also, Aneco Reinsurance Underwriting Ltd v Higgins [1998] 1 Lloyd’s Rep 565.

Notes: 1. Longmore J’s approach in Marc Rich is clearly discernible in the recent decision of the Court of Appeal in Assicurazioni (below, [408]) in which Clarke LJ drew a sharp distinction

between materiality on the one hand, and inducement on the other. It was stressed that while the determination of materiality was based on an objective test, the question of inducement was clearly a subjective issue. Further, although the non-disclosed or misrepresented fact need not be the sole inducement (see also the St Paul’s Fire case, above) it must be effective in causing the actual insurer to enter into the contract. 2. Significantly, the majority of the court doubted whether there was a presumption of law that an insurer was induced. This has the unfortunate consequence of leaving Lord Mustill’s presumption of inducement in some doubt — although, of course, it must be borne in mind that Assicurazioni is a decision of the Court of Appeal. [408] Assicurazioni Generali SpA v Arab Insurance Group (BSC) [2003] 1 WLR 577 (CA) [The facts are immaterial]. Clarke LJ: ‘Before considering the issues of fact, it is convenient to discuss briefly the relevant legal principles. Non-disclosure It is common ground that the relevant principles are stated by the House of Lords in Pan Atlantic Insurance Co Ltd v Pine Top Insurance Co Ltd [1995] 1 AC 501. In order to be

entitled to avoid a contract of insurance or reinsurance on the ground of non-disclosure the insurer or reinsurer must show that the fact not disclosed was material and that its non-disclosure induced the contract…

Materiality In Pan Atlantic the House of Lords, by a majority, held that to be material a fact did not have to have a decisive influence on the mind of the prudent underwriter. The test is that stated in subsections 18(2) and 20(2) of the Marine Insurance Act 1906, which relate to non-disclosure and misrepresentation respectively and which the House of Lords held set out the common law principles relevant to non-marine (as well as marine) insurance… Inducement In Pan Atlantic the House of Lords held that the material non-disclosure or misrepresentation must induce the contract. It was expressly held that it is not sufficient that the non-disclosure or misrepresentation is material… It was not necessary for Lord Mustill to consider the precise meaning of “induced” in the general law of contract. Lord Mustill did, however, refer to a presumption of inducement which has been given some consideration subsequently: see eg Clarke on The Law of Insurance Contracts, 3rd edition paragraph 22–3C, Arnould on The Law of Marine Insurance, 16th edition, volume 3, paragraph 611, and St Paul Fire & Marine Insurance Co (UK) Ltd v McConnell Dowell Constructors Ltd [1995] 2 Lloyd’s Rep 116. In paragraph 611 of Arnould the editors say: “Under the general law, a misrepresentation need not be the sole inducement, but must have been a real and substantial cause affecting the decision of the representee to enter into the contract, or to do so on the terms agreed.”

They cite as examples JEB Fasteners Ltd v Marks, Bloom & Co [1983] 1 All ER 583 and Edgington v Fitzmaurice (1885) 29 Ch D 459. In paragraph 22–3C of Clarke it is said that what is usually required is what is identified as a type B representation, which is defined as follows: “Type B is a representation such that, if the recipient had known the truth, he would still have been willing to make the contract, but only on different terms, notably, but not only as to premium.” It seems to me that the true position is that the misrepresentation must be an effective cause of the particular insurer or reinsurer entering into the contract but need not of course be the sole cause. If the insurer would have entered into the contract on the same terms in any event, the representation or non-disclosure will not, however material, be an effective cause of the making of the contract and the insurer or reinsurer will not be entitled to avoid the contract… Those principles seem to me to be consistent with the approach of this court in St Paul Fire & Marine v McConnell: see per Evans LJ (with whom Rose and Nourse LJJ agreed) at pages 124–5, where he discussed the general principles, and at page 127, where he held that, if the three underwriters who gave evidence had been told the truth, on no view would they have underwritten the insurance at the same premium on terms which included subsidence risk. Evans LJ also considered the role played by presumption in this class of case. He did so in the context of a fourth underwriter who was not called to give evidence, no doubt because the trial took place before the decision of the House of Lords in Pan Atlantic… Evans LJ put the position thus at page 127:

“The existence of such a presumption is recognised in the authorities; see Halsbury’s Laws vol 31 par 1067 where the law is stated as follows: Inducement cannot be inferred in law from proved materiality, although there may be cases where the materiality is so obvious as to justify an inference of fact that the representee was actually induced, but, even in such exceptional cases, the inference is only a prima facie one and may be rebutted by counter evidence.” The authorities cited include Smith v Chadwick (1884) 9 App Cas 187 and in my judgment they justify the above statement of the law. This provides a reminder of the need to distinguish “materiality” from “inducement”, although inevitably the two overlap. Here, the evidence of the three underwriters who did give evidence and of the expert witnesses was clear. If the underwriters had been told the true state of the ground conditions, as revealed by the 1982 report, and of the conflicting views expressed by the authors of that report…then they would have called for further information and in all probability either refused the risk or accepted it on different terms. In fact, all four underwriters including Mr Earnshaw accepted it without any relevant enquiries. There is no evidence to displace a presumption that Mr Earnshaw like the other three was induced by the non-disclosure or misrepresentation to give cover on the terms on which he did. In my judgment, these insurers also have discharged their burden of proof. It appears to me that a presumption of this kind really amounts to no more than this. It simply operates where the evidence before the court is enough to lead to the inference that the insurer or reinsurer was, as a matter of fact, induced to enter into the contract. In all the circumstances I would summarise the relevant principles of inducement in this context in this way:

1. In order to be entitled to avoid a contract of insurance or reinsurance, an insurer or reinsurer must prove on the balance of probabilities that he was induced to enter into the contract by a material non-disclosure or by a material misrepresentation. 2. There is no presumption of law that an insurer or reinsurer is induced to enter in the contract by a material non-disclosure or misrepresentation. 3. The facts may, however, be such that it is to be inferred that the particular insurer or reinsurer was so induced even in the absence from evidence from him. 4. In order to prove inducement the insurer or reinsurer must show that the non-disclosure or misrepresentation was an effective cause of his entering into the contract on the terms on which he did. He must therefore show at least that, but for the relevant nondisclosure or misrepresentation, he would not have entered into the contract on those terms. On the other hand, he does not have to show that it was the sole effective cause of his doing so. …’

4.1.3 Non-Disclosure in the Proposal Form and the Issue of Waiver Insurance is generally effected by the insured answering questions contained in a proposal form. Where such answers are declared to be ‘the basis of the contract’ that has the effect of preventing any argument as to the materiality of those questions (see further, chapter 8). But the mere fact that the insurer has asked particular questions does not

relieve the insured of his general obligation at common law to disclose any material fact which might affect the risk, or which might affect the mind of the insurer as to whether or not he should issue a policy. An issue that arises in this context is whether an insurer can be taken to have waived (see section 18(3)(c) of the 1906 Act) the right to information by virtue of the way in which questions are framed in the proposal form. A question may stipulate a time period, for example: ‘Have you made an insurance claim during the last five years’. In such a case the insurer would be taken to have waived disclosure of claims outside the specified time notwithstanding that such claims would satisfy the test of materiality. Ultimately, whether or not there is waiver is a question of construction and in cases of ambiguity the particular question asked will be construed contra proferentum. The position was succinctly stated by Woolf J in Hair v Prudential Assurance Co [1983] 2 Lloyd’s Rep 667: ‘It is more likely…that questions asked will limit the duty of disclosure, in that, if questions are asked on particular subjects and the answers to them are warranted, it may be inferred that the insurer has waived his right to information either on the same matters but outside the scope of the questions or on kindred matters to the subject-matter of the question. Thus, if an insurer asks “How many accidents have you had in the last three years?” it may well be implied that he does not want to know of accidents before that time, though these would still be material. If he were to ask whether any of the proposer’s brothers or sisters had died

on consumption or had been inflicted with insanity it might well be inferred that the insurer had waived similar information concerning more remote relatives, so that he could not void the policy for nondisclosure of an aunt’s death of consumption or an uncle’s insanity. Whether or not such waiver is present depends on a true construction of the proposal form, the test being: Would a reasonable man reading a proposal form be justified in thinking that the insurer had restricted his right to receive all material information and consented to the omission of the particular information in issue?’

In Phoenix Life Assurance Co v Raddin 120 US 183 (1886) the US Supreme Court observed that: ‘Where an answer of the applicant to a direct question of the insurer’s purports to be a complete answer to the question, any substantial misstatement or omission in the answer avoids the policy issued on the faith of the application…But where upon the face of the application a question appears to be not answered at all, or to be imperfectly answered and the insurers issue a policy without further inquiry, they waive the want or imperfection in the answer, and render the omission to answer fully immaterial.’

[409] Schoolman v Hall [1951] 1 Lloyd’s Rep 139 (CA) [The facts appear from the judgment of Cohen LJ]. Cohen LJ: ‘The case arises out of a Lloyd’s policy known as a “Jewellers’ Block Policy, “issued on 18 November 1948, by Lloyd’s underwriters to the plaintiff in respect of jewellery owned by him and in connection with a retail jeweller’s

business carried on by him at No 467, Oxford Street, London, W 1. Unfortunately, he suffered a burglary — and it is not now disputed that it was a genuine burglary — on 21 December 1948. The underwriters refused to recognise his claim, and, as a result, proceedings in that connection were commenced on 14 May, 1949. By his defence the defendant set up as the main defence, or, at any rate, the only defence at issue at the trial, this: In order to induce the defendant to make and grant to the plaintiff the policies aforesaid the plaintiff concealed from the defendant a fact then material to be known to him, but of which the defendant was ignorant, that is to say, that the plaintiff had a criminal record. Then follow particulars of the criminal record which, I think, I need not specify in detail; it is sufficient to mention that it covers a period from 1927 to 1934… The question is whether he ought to have disclosed that criminal record up to that date. In his reply the plaintiff, while admitting that he failed to disclose his criminal record, claimed that he was released from his obligation by the defendant…he said that he would rely upon the questions, terms and all the contents of the written proposal which the defendant required the plaintiff to make for the purpose of obtaining insurance, and upon the answers and statements made by the plaintiff in the said written proposal… In order that the point thus raised may be fully appreciated, I must turn now to the form of that questionnaire. That questionnaire is undated, but in fact it was filled in some time in 1948. On it there were no less than 15 questions, all of which I think can clearly be described as being in the nature of trade questions, namely: nature of the business; protection against burglary, safes and the like; window display; stock; travelling in connection with the business; the sending of goods comprised in the business in the United Kingdom and elsewhere; exhibition of stock at any exhibition. All those last seven questions, I

think, are confined to a period of a year before the proposal form is filled in. Then comes: “Losses: Have you ever sustained a loss or losses? If so, give statement covering past five years with particulars, amounts claimed, and whether paid in full or otherwise.” No. 12 is a question about the fire insurance rate. Then follows: “13. For what amount is the policy required? 14. References: Unless proposing for renewal, please give two references from your trade. 15. (a) Have Lloyd’s or any insurer ever cancelled or refused to issue or to continue any insurance for you? (b) Have you been previously insured? If so, state where, risks covered, and for what amount?” Then come these words upon which some reliance is placed: “Signing this form does not bind the proposer to complete the insurance, but it is agreed that this form shall be the basis of the contract should policy be issued.” …[T]wo issues were raised by Mr Marshall, who then appeared for the plaintiff. First, he argued that, having regard to the terms of the proposal form, the defendant must be regarded as having waived any requirements for further information other than that contained in the answers to the questions in the proposal form, that is to say, five years before the form was completed. In the alternative, he alleged that this criminal record, relating, as it did, to matters which had occurred long before — the most recent being 15 years before the trial — was not a material fact. So far as the first issue was concerned, the learned Judge ruled that on the question of waiver there was no evidence

to go to the jury on the point, and he left the other question to the jury — the question of materiality of the nondisclosure of the criminal record. The jury found that that was non-disclosure of a material fact. From that finding, Mr Ashe Lincoln recognises he cannot successfully appeal — there being clear evidence in support of that finding — but, he says, the learned Judge misdirected himself as to the meaning and consequence of the proposal form, and that, even if he had not misdirected himself, there was still an issue which ought to have been left to the jury, namely, whether any reasonable man, looking at that application form and construing it as it ought to be construed, would think he was under an obligation to disclose a criminal record in relation to a period so long before the date of the application form?… In the present case, Mr Ashe Lincoln asks us to draw the inference, from the nature of the questions that are put to the proposer in the proposal form, that the insurer is indifferent to anything but trade matters, and, he would add, to anything which occurred more than five years before. He did feel a little difficulty about the latter submission, because he was bound to admit that, in the only two clauses which could be said in any way to refer to questions of a moral character -that is, “No 14. References,” and No 15 as to refusal or continuance of other insurance policies — there was no time limit whatsoever. But, he said, elsewhere in six questions the time limit was 12 months, and as to “Losses” the time limit was five years, and so, he said, anybody reasonably reading this proposal form would jump to the conclusion, or might jump to the conclusion, that such ancient history as a fifteen-year-old criminal record was not relevant. The difficulty I feel, however, is that the questions in the proposal form are, in substance, confined to trade matters, and, like the learned Judge, I cannot spell out of it any waiver of the ordinary right of the intending insurer to the

disclosure of material facts dealing with other matters which might influence the mind of the insurer in deciding whether or not to issue a policy… So, I think [applying the observations of Lord Dunedin in Glicksman v Lancashire and General Assurance (see below, [419])…while the insurers have stipulated that the answers to the fifteen questions “shall be the basis of the contract,” that only has the effect of preventing any argument as to the materiality of those questions should dispute arise, but it does not relieve the proposer of his general obligation at common law to disclose any material which might affect the risk which was being run, or which might affect the mind of the insurer as to whether or not he should issue a policy… For these reasons, I think that the argument as to waiver cannot be sustained and that the decision of the learned Judge was right. This appeal must therefore be dismissed.’

See also, New Hampshire Insurance Refineries Ltd [2002] Lloyd’s Rep 462.

Co v Oil

Notes: 1. An issue that has arisen recently is whether the failure of an insurer to stop collecting premiums under a direct debit mandate after avoidance is sought for nondisclosure can constitute waiver. In Drake Insurance plc v Provident Insurance plc [2003] All ER (D) 02, the insured had failed to disclose a speeding conviction when renewing his motor policy. Moore-Brick J held that the defendant insurer was induced to renew and was therefore entitled to avoid the policy. On the issue of waiver, the judge considered that the automatic collection of

premiums was insufficient evidence of any intent to waive avoidance. 2. An important matter that has come before the courts is the extent to which the parties can exclude or vary the duty of utmost good faith by a contract term. [410] HIH Casualty and General Insurance Ltd v Chase Manhattan Bank [2001] Lloyd’s Rep IR 703 (CA) [The policies in question (time variable cover policies, hereafter TVC) related to high risk film finance insurance. They contained exclusion clauses (termed “truth of statement” clauses) which provided, inter alia, that “[3]…any misstatement…shall not be the responsibility of the insured or constitute a ground for avoidance of the insurers’ obligations under the Policy” and that “[6]…[the insured] will not have any duty or obligation to make any representations, warranty of disclosure of any nature express or implied…” [7]…and shall have no liability of any nature to the insurers for any information provided by any other parties and [8]…any such information provided by or non-disclosure by other parties…shall not be a ground or grounds for avoidance of the insurers’ obligations under the Policy…” The issues for the Court of Appeal were whether (i) given the fraudulent, reckless or negligent nondisclosures by the brokers, Heaths, were the insurers, HIH, entitled to avoid the policies notwithstanding the “truth of statement” clauses; and (ii) were the

insurers entitled to damages from the insured, Chase, or the brokers, or both. It was held that the clauses were wide enough in scope to exclude liability for misrepresentation and non-disclosure by the brokers. However, the wording of the particular clauses was not sufficient to prevent the insurers from avoiding the policies vis-à-vis the insureds. Rix LJ, agreeing with the trial judge, noted that while, as a matter of public policy, no person can exclude liability for his or her own fraudulent conduct, it is possible to exclude liability for the fraudulent misrepresentations of an agent (although ‘it may be different…if the principal is in some way implicated in the agent’s fraud’). However, he thought that in practice it would be rare to find a form of wording for such an exclusion clause that would be acceptable to the other contracting party: ‘To warn a potential contract party of an agent’s possible fraud would be a remarkable clause to find in any agreement’]. Rix LJ: Where non-disclosure is concerned…the law has not distinguished, as far as I am aware, certainly not in the same way [as with misrepresentation], between innocent, negligent and fraudulent non-disclosure…It has not been suggested in this Court…that non-disclosure of itself can give rise to any cause of action, other than to the remedy of avoidance in the context of the duty of good faith, even where the non-disclosure may be described as fraudulent… the [trial] Judge held that there was no remedy in damages for breach of the duty of good faith and said nothing in his judgment or his order to allow for any remedy in damages

for fraudulent non-disclosure. There has been no appeal from that. For the purposes of the current appeal and cross-appeal therefore I approach the matter on the basis that even where the non-disclosure is fraudulent there is no remedy in damages pursuant to the duty of good faith. Moreover, whether there is a remedy in the tort of deceit has simply not been the basis of any consideration, here or below…It follows that for the purposes of the argument in this case no distinction arises in the matter of remedies whether a nondisclosure is innocent, negligent or even fraudulent: whichever it is, the only remedy contemplated is that of avoidance. The only relevant purpose, therefore, for distinguishing between an innocent, negligent or fraudulent non-disclosure is to test whether an exclusion of the right to avoid for non-disclosure operates equally for all three kinds of non-disclosure. In this connection the next matter for consideration is what is meant by a fraudulent non-disclosure. The term has never been defined. Sometimes it is referred to as a deliberate concealment: but I am by no means sure that the two can be equated. A matter may be deliberately concealed in the honest but mistaken belief that it is not relevant or material or that enquiry of it has been waived. There may be nothing dishonest in that, but ex hypothesi the remedy of avoidance remains…No authority has been cited for a definition of fraudulent non-disclosure: and the absence of such authority in my judgment is not a merely collateral matter but intimately connected with the current problem of asking whether it makes sense to distinguish between fraudulent and non-fraudulent non-disclosure. I am doubtful that it is. No case has been cited in which the distinction has been material to any remedy or absence of remedy under an insurance contract. On the other hand a distinction is sometimes drawn by the policy itself. Thus in Arab Bank Plc v Zurich Insurance Co

[1999] 1 Lloyd’s Rep 262 there was an “Innocent Nondisclosure” clause which excluded the insurer’s right to avoid for non-disclosure or misrepresentation where the assured could establish that “such alleged non-disclosure, misrepresentation or untrue statement was innocent and free of any fraudulent conduct or intent to deceive”. So there the clause itself distinguished on the basis of “fraudulent conduct or intent to deceive”. It would seem that dishonesty rather than deliberateness was the test. In the absence of express language, however, I know of no authority which requires a distinction between the possible causes of non-disclosure. In saying that I am conscious that in Carter v Boehm itself Lord Mansfield does seem to have considered that there was a difference between the concealment which the duty of good faith prohibited and mere silence…As a result nondisclosure in the insurance context in the early years was referred to as “concealment”, and the doctrine has sometimes been viewed and explained as constructive fraud. However, Lord Mansfield was seeking to propound a doctrine of good faith which would extend throughout the law of contract, and in that respect his view did not bear fruit. Where, however, in the insurance context it put down firm roots, it came to be seen as a doctrine which went much further than the antithesis of fraud, and, as it has come to be developed, “non-disclosure will in a substantial proportion of cases be the result of an innocent mistake” (Pan Atlantic Insurance Co. Ltd. v Pine Top Insurance Co. Ltd. [above, [405]], per Lord Mustill). In sum, I do not think that, in the absence of express language, any line is to be drawn between the various possible causes of or motives for non-disclosure. It is not in this way that the distinction is to be drawn. The question to my mind is whether a non-disclosure can support a claim in fraud, with its remedies in damages and/or rescission: either because of an analysis it amounts or gives rise to a

fraudulent misrepresentation or perchance for any other reason. Aikens J has held in effect…that only misrepresentation, and not non-disclosure, can give a remedy in damages for fraud, and there has been no appeal from that conclusion…If a distinction is drawn by contract, then effect will have to be given to that distinction according to its terms (cf. Arab Bank v Zurich Insurance). In the absence of such contractual provision, however, I do not think that the law has so far equipped itself to mark out the fine lines which would have to be drawn between the various degrees of culpable non-disclosure.’

Note: The Court in HIH thus confirmed that as far as nondisclosure is concerned the law does not distinguish between innocent, negligent and fraudulent nondisclosure. Further, nondisclosure does not give rise to any corresponding duty of care in tort. However, in the House of the Lords (see below, [411]), Lord Bingham explained that “where the nondisclosure or misrepresentation were other than innocent, the insurer might have rights additional to that of avoidance: the right to damages given by section 2(1) of the Misrepresentation Act 1967 to the victim of the negligent misrepresentation; and the right to recover damages for deceit given by the common law to the victim of a fraudulent misrepresentation.’ (See also the speech of Lord Hobhouse). [411] HIH Casualty and General Insurance Ltd v Chase Manhattan Bank [2003] Lloyd’s Rep 61 (HL)

[The questions for the House of Lords to decide were a series of preliminary issues on the construction of the ‘truth of statement clauses’ (see [410], above)]. Lord Bingham: ‘The issues between the parties concern the correct interpretation of a “Truth of Statement” clause contained in policies of insurance made between Chase (as representative of a syndicate of lending banks) as the insured and HIH which, although now in liquidation and not an appellant, has been treated as the lead company among a group of underwriting companies… Chase was advancing substantial sums to finance the making of future films. If the films, when made, proved successful and generated substantial revenue, Chase would expect or hope to recoup its outlay from the revenue stream assigned to it. But the films might not prove successful and might either produce no revenue stream or a revenue stream insufficient, after deductions, to repay the loan. To the extent that the revenue stream fell short of the sum advanced, Chase would look to the insurance policies. These provided the security without which, it seems safe to infer, Chase would not have lent at all… When the phrases numbered [6], [7] and [8] in the truth of statement clause are read against the backcloth of the general law very briefly summarised in the last paragraph of this opinion [in which his Lordship had recited sections 17– 20 of the 1906 Act], three points are immediately striking. First, Chase as the insured, although expressly relieved of any obligation to make any representation at all (phrase [6]), is not relieved of liability for any misrepresentation which it may voluntarily choose to make. Secondly, Chase is expressly relieved of any duty or obligation to make any disclosure of any nature (phrase [6]). Thirdly, no attempt has been made (whether by joining Heaths as a party to the

contract or in any other way) to relieve Heaths of any liability to which it might be liable as an agent. The parties have left Heaths to look after itself. In the present case, no allegations of misrepresentation or non-disclosure have been made against Chase at all, so the crucial question is: in what circumstances and to what extent, on a proper interpretation of the truth of statement clause, is Chase to be liable for misrepresentation or non-disclosure by Heaths? While the clause must of course be read as a whole, it can only be conveniently analysed by considering in a little detail the three phrases on which the argument turns. Phrase [6] This phrase reflects the obvious intention of the draftsman to distance Chase from the underlying transaction. It need make no representation and no disclosure, such duties being expressly waived. It was argued for Chase that this waiver relieved Heaths also of its disclosure duty, since s. 18(3) of the 1906 Act provides that — “In the absence of inquiry the following circumstances need not be disclosed, namely… (c) Any circumstance as to which information is waived by the insurer…” Since the disclosure obligation of the agent under section 19 is expressly subject to the provisions of section 18 as to circumstances which need not be disclosed, it was argued, the insurers’ waiver of Chase’s duty relieved Heaths also and thus operated to relieve Chase of any liability as principal. This is not in my opinion a tenable argument. For reasons which are readily understandable in the commercial context, the insurers relieved Chase of its usual obligation to disclose. It could not be supposed that the insurers did not require any disclosure of information of material

circumstances, only that they were not looking to Chase to get it. Phrase [6] makes plain that the insurers were not waiving disclosure of information of any material circumstances but were relieving Chase of its disclosure obligation altogether. Chase relied in argument on the rhetorical question posed by Saville LJ in Société Anonyme d’Intermediaries Luxembourgeois v Farex Gie [1995] LRLR 116 at p 157: “Why should it be a breach of good faith sufficient to deprive the assured of his contract if the agent fails to disclose something which, had the assured known of it, would not have had to have been disclosed by the latter?” But on the present assumed facts the answer is clear: it is a breach because the insurers have chosen to rely not on disclosure by Chase, distanced from the detail of the transaction, but on disclosure by the agent, actively involved. Phrase [7] It was common ground, and rightly so, that phrase [7], read with phrase [8], precludes avoidance of the policy by the insurers on the ground of innocent misrepresentation by Heaths: if the phrase does not have that effect, it has no effect at all. But the parties were divided as to how much further protection the phrase gives to Chase and in particular whether its effect is to deny Heaths’ authority to speak for Chase and whether it denies the insurers their usual remedies if Heaths were guilty of negligent or fraudulent misrepresentation. Chase contended that the effect of phrase [7] is to deny the authority of Heaths to speak for Chase. The Judge and the Court of Appeal both rejected this argument: [2001] 1 Lloyd’s Rep 30, paras 47, 70; [2001] 2 Lloyd’s Rep 483, para 144. These decisions were plainly correct. There is nothing

in the clause which could reasonably be understood as denying or restricting the implied and apparent authority of Heaths as Chase’s agent. In submitting that phrase [6] does not deny the insurers their usual legal remedies for negligent misrepresentation by Heaths, the insurers drew sustenance from the wellknown principles propounded by Lord Morton of Henryton giving the judgment of the Board in Canada Steamship Lines Ltd v The King [1952] AC 192 at p 208. There can be no doubting the general authority of these principles, which have been applied in many cases, and the approach indicated is sound. The Courts should not ordinarily infer that a contracting party has given up rights which the law confers upon him to an extent greater than the contract terms indicate he has chosen to do; and if the contract terms can take legal and practical effect without denying him the rights he would ordinarily enjoy if the other party is negligent, they will be read as not denying him those rights unless they are so expressed as to make clear that they do. But, as the insurers in argument fully recognised, Lord Morton was giving helpful guidance on the proper approach to interpretation and not laying down a code. The passage does not provide a litmus test which, applied to the terms of the contract, yields a certain and predictable result. The Courts’ task of ascertaining what the particular parties intended, in their particular commercial context, remains. In relation to negligent misrepresentation, the key to the understanding of phrase [7] in my view lies in the provision that Chase shall have “no liability of any nature…”. This is comprehensive language, clearly chosen to give Chase an extended immunity. It cannot refer simply to the liability of Chase to suffer the avoidance of the contract, since that is the subject of express provision in phrase [8]. So the language must be intended to preclude the liability of Chase for damages under section 2(1) of the 1967 Act for any

negligent misrepresentation by Heaths and also any right of the insurers to avoid the policy on that ground. I find nothing commercially surprising in this interpretation, from the viewpoint of Chase or the insurers. In a complex transaction of this kind, the possibility that Heaths as agent might make and fail to correct a representation which was later held to be both untrue and negligent would be very real. Chase, distanced from the transaction, would have little knowledge of what was represented and little opportunity to correct it. It could reasonably seek protection against loss or diminution of its security on such a ground. The insurers for their part might reasonably accept this chink in their armour, recognising that their rights against Heaths in such an eventuality would remain unimpaired. Does phrase [7] then operate to protect Chase against any liability for damages or any risk of avoidance if the insurers should be induced to enter into the contract by any fraudulent misrepresentation of Heaths acting as the agents of Chase? In submitting that such is the effect of the phrase, Lord Grabiner QC for Chase emphasised the comprehensive language already noted, “no liability of any nature”. Read literally, those words would cover liability for fraudulent misrepresentation, or deceit. If Chase’s security for its loan is to be cast-iron, the policy must stand even if induced by the deceit of Heaths. This is not a negligible argument. But neither the Judge nor the Court of Appeal accepted it and I am satisfied that they were right not to do so. For, as Rix LJ observed more than once in his judgment (paras 160, 169), fraud is a thing apart. This is not a mere slogan. It reflects an old legal rule that fraud unravels all: fraus omnia corrumpit. It also reflects the practical basis of commercial intercourse. Once fraud is proved, “it vitiates judgments, contracts and all transactions whatsoever”: Lazarus Estates Ltd v Beasley [1956] 1 QB 702 at p 712, per Denning LJ. Parties entering

into a commercial contract will no doubt recognise and accept the risk of errors and omissions in the preceding negotiations, even negligent errors and omissions. But each party will assume the honesty and good faith of the other; absent such an assumption they would not deal. What is true of the principal is true of the agent, not least in a situation where, as here, the agent, if not the sire of the transaction, plays the role of a very active midwife… It is clear that the law, on public policy grounds, does not permit a contracting party to exclude liability for his own fraud in inducing the making of the contract. The insurers have throughout contended for a similar rule in relation to the fraud of agents acting as such…I do not however think that the question need be finally resolved in this case. For it is in my opinion plain beyond argument that if a party to a written contract seeks to exclude the ordinary consequences of fraudulent or dishonest misrepresentation or deceit by his agent, acting as such, inducing the making of the contract, such intention must be expressed in clear and unmistakable terms on the face of the contract…I think it clear that…the language of phrase [7] falls well short of what is required to meet Chase’s objective, as both the Judge (para 81(3)) and the Court of Appeal (paras 159, 160) held. Phrase [8] In relation to misrepresentation, phrase [8] adds nothing to phrase [7]: there may be no avoidance for innocent or negligent misrepresentation, but the phrase does not, for reasons already given, apply to fraudulent misrepresentation. In relation to non-disclosure, there was some difference of opinion between the Judge and the Court of Appeal. I think it plain, giving fair effect to the language of this phrase, that innocent or negligent non-disclosure by Heaths is to give the insurers no right to avoid the policy. The

phrase refers to “any…non-disclosure by other parties…”; the English law on non-disclosure is widely recognised to be very strict; and any other reading would weaken Chase’s security to a point which would, it may be inferred, have been unacceptable to it. But fraudulent non-disclosure raises a more difficult problem. The Judge held that phrase [8] did not exclude the insurers’ right to avoid the contract of insurance in circumstances where the breach of the independent duty of disclosure by Heaths was the result of deliberate concealment of material facts: [2001] 1 Lloyd’s Rep 30, paras 76–77. In the Court of Appeal, doubt was cast on the meaning of “fraudulent non-disclosure” ([2001] 2 Lloyd’s Rep 483, para 165) and it was questioned whether the law had distinguished between innocent, negligent and fraudulent non-disclosure (paras 163, 168)… …Rix LJ makes an important but uncontentious point: that silence, where there is a duty to speak, may amount to misrepresentation…Since an agent to insure is subject to an independent duty of disclosure, the deliberate withholding from the insurer of information which the agent knows or believes to be material to the risk, if done dishonestly or recklessly, may well amount to a fraudulent misrepresentation. If, in the present case, the insurers establish nondisclosure by Heaths of this kind, nothing in the truth of statement clause deprives them of their ordinary right to avoid the policy and recover damages against Chase and Heaths. Whether, on the facts of this case, the insurers can establish any deliberate and dishonest or reckless nondisclosure by Heaths which does not amount to a misrepresentation, must be doubtful. In Pan Atlantic Insurance Co Ltd v Pine Top Insurance Co Ltd [1995] 1 AC 501 at p 549, Lord Mustill pointed out that “in practice the line between misrepresentation and nondisclosure is often imperceptible.” But section 84 of the 1906 Act appears to

accept the possibility of fraudulent non-disclosure and I do not think such possibility need be rejected on conceptual grounds. If it were to be established, I would agree with the Judge that phrase [8] does not exclude the insurers’ ordinary right to avoid. I would for my part answer the preliminary issues in this way: On the true construction of the contracts of or for insurance pleaded in the [amended] particulars of claim No 1999 Folio 1413 [the insurers’ action] and on the assumption that the facts and matters pleaded in those particulars of claim are true, the insurers are entitled in law (a) to avoid and/or rescind the contracts of or for insurance against Chase on the grounds, but only on the grounds, of fraudulent misrepresentation or as regards the contracts of insurance fraudulent nondisclosure by Heaths as agent of Chase; (b) to damages from Chase for, but only for, fraudulent misrepresentation by Heaths as agent of Chase and fraudulent non-disclosure by Heaths as agent of Chase if, but only if, such fraudulent non-disclosure by Heaths amounts to fraudulent misrepresentation. On the Court of Appeal’s narrow point relating to fraudulent non-disclosure not amounting to misrepresentation, the insurers’ appeal succeeds, and should be allowed to that extent. The cross-appeal by Chase fails and must be dismissed.’

4.1.3 Proving Non-Disclosure Expert evidence may be adduced by an insurer to assist the court in its determination of whether or not a non-disclosed fact is material (see Yorke v Yorkshire Insurance Co Ltd [1918–19] All ER Rep 877, per

McCardie J; and Roselodge Ltd v Castle (below, [414])). The determination of materiality is necessarily a fact intensive exercise: see, for example, James v CGU Insurance plc [2002] Lloyd’s Rep IR 206. [412] Reynolds v Phoenix Assurance Co [1978] 2 Lloyd’s Rep 440 [The issue of reinstatement that arose in this case is considered in chapter 13, [1304]; the insured’s failure to disclose a criminal conviction is considered below, [418]. Forbes J: ‘Before coming on to the evidence itself I should consider one further preliminary point. In this branch of the law it is permissible for either side to adduce evidence relating to what would be regarded as material. The question at once arises, what is the nature of such evidence and what are the powers and duties of the Court in relation to it? Mr Wilmers maintains that the Court’s only duty is to listen to the evidence, decide whether the witness is telling the truth and, if he is, go on to decide whether he is a reasonable and prudent underwriter. If both decisions are favourable then the Court must act on that evidence. Now I should say at once that I am satisfied that all the insurance witnesses (and such witnesses are called by both sides) were truthful in so far as they dealt with factual questions and also that they all appeared to me to be at any rate prudent underwriters. So far as the word “reasonable” is concerned Mr Wilmers says this merely means “rational” and has none of the connotations of the word as used in the term the

“reasonable man”. Apparently underwriters never ride on the Clapham omnibus. Now I do not accept these arguments. In the first place the evidence of insurers called in this way is expert evidence in the sense that such witnesses are assisting the Court in deciding what a reasonable and prudent underwriter would or would not do. They are not to give evidence of what they themselves would do, because their evidence is expert, that is opinion evidence and not factual. They are to give evidence of what, in their opinion, having regard to the general practice of underwriters, a reasonable underwriter would do. There is a world of difference between saying — “A reasonable underwriter, in my opinion, would do so and so: I would do so myself”; and saying — “I would do so and so, and because I am a reasonable underwriter, it must follow that that is what a reasonable underwriter would do”. The former is unobjectionable expert evidence; the latter is not only logically fallacious but also not really acceptable evidence at all…The test of such a witness is not whether he is telling the truth, but whether he is giving an honest opinion. Further, in giving expert evidence such witnesses are only assisting the Court not deciding the matter. It seems to me therefore that although I may derive assistance from such expert testimony as has been put before me, I am not bound to regard it as conclusive of what a reasonable and prudent underwriter would do.’

4.1.4 (iii) Scope of the Duty It will be recalled that section 18 of the 1906 Act requires disclosure of all facts which are known or presumed to be known by the insured and which are material to the underwriter’s determination of the

risk. Facts known or presumed to be known by the underwriter need not be disclosed. Decisions illustrating the scope of the insured’s duty of disclosure typically relate either to physical or moral hazard. The latter category is generally concerned with the insured’s claims history (including prior refusals to insure) or criminal past.

4.1.5 Physical Hazard Physical hazard can pose problems especially in life or health insurance because an insured may not be aware that a particular condition is symptomatic of a more serious health risk. In Joel v Law Union and Crown Insurance Co (1908) 99 LT 712, FletcherMoulton LJ gave the following example: ‘I will suppose that a man has, as is the case with almost all of us, occasionally had a headache. It may be that a particular one of these headaches would have told a brain specialist of hidden mischief, but to the man it was an ordinary headache indistinguishable from the rest. Now, no reasonable man would deem it material to tell an insurance company of all the casual headaches he had had in his life, and if he knew no more as to this particular headache, there would be no breach of his duty towards the insurance company in not disclosing it.’

[413] Cook v Financial Insurance Co Ltd [1998] 1 WLR 1765 (HL)

[Cook effected disability insurance with FI commencing on 15 October 1992. The policy contained an exclusion clause which provided that: “No benefit will be payable for disability resulting from (a) any sickness, disease, condition or injury for which an insured person received advice, treatment or counselling from any registered medical practitioner during the 12 months preceding the commencement date…” The insured, who regularly went running, collapsed in July 1992 while on a training run. He saw his GP but she could find nothing untoward. On 4 September he again visited her complaining of pain and breathlessness while running. She thought he may be suffering from a viral infection but referred him by letter dated 7 September to a cardiologist to exclude the possibility of angina. On 16 October the insured was examined by the cardiologist who diagnosed angina. In December he was advised to give up work and he claimed under the policy on the ground that he was unable to work due to angina. The insurers refused payment relying on the exclusion clause.] Lord Lloyd: ‘The questions which arise on these facts may be stated as follows. (1) Did the plaintiff receive advice, treatment or counselling for angina prior to 15 October? If not, (2) is it enough to bring the case within the exclusion that he received advice, treatment or counselling for symptoms which later turned out to be those of angina? If, as I think, treatment for a disease requires some knowledge on the part of the doctor of the disease which he is treating, in order to bring the case within the exclusion

clause, so advice for a disease must also require knowledge on the part of the doctor of the disease about which he is giving advice. A doctor does not give advice within the meaning of the clause by saying, “I do not know what is wrong with you; go and see another doctor.” The earliest date on which the plaintiff received advice for angina was therefore 16 October, when he saw Mr Flint. If on 7 September Dr Thorns had suspected angina, it might have been different. But on the facts as found by the judge, that was not the case. Dr Thorns did not suspect angina. She chose to exclude angina by getting a second opinion. But she might just as well have chosen to exclude respiratory disease. I turn to the second question. Is it enough that the plaintiff received advice for symptoms which turned out to be those of angina? In my opinion the answer must also be “No,” unless the insurers can read the word “condition” as including symptoms of a generalised kind which might indicate any number of different diseases, or none… The point is a narrow one, and made to seem all the narrower because the contract of insurance was concluded on the day before the plaintiff saw the consultant. But one can imagine cases where the timescale is much longer. Take a man who complains to his doctor that he is suffering from headaches. The doctor can find nothing wrong, and recommends a strong painkiller. Eventually it transpires that the man has a brain tumour. Can it really be said that he received advice for his brain tumour when he first went to see his doctor? Clearly not. Nor, I think, can it be said that he received advice for his condition. At the other end of the scale one might take the case of a man with a very high temperature who is taken to an isolation hospital suffering from Cape Congo Fever or some other rare disease. Obviously he is receiving treatment within the meaning of the exclusion clause from the

moment of his arrival in hospital, even though the disease cannot at first be diagnosed… In the present case the plaintiff signed a declaration that he had not consulted a doctor other than for minor illnesses. When he came to read the exclusion clause he was entitled to assume that it related only to major illnesses for which he had consulted a doctor. It could not relate to minor illnesses with which, as the insurers had made clear from the form of the declaration, they were not concerned…I would allow the appeal.’

4.1.6 Moral Hazard Previous convictions of the insured and connected persons [414] Roselodge Ltd v Castle [1966] 2 Lloyd’s Rep 113 [The insureds who were diamond merchants effected an all risks policy with the insurers. The proposal form did not ask, and the insureds did not disclose, whether any of their employees had previous convictions. When the insureds sought to recover under the policy on the ground that R, their principal director, had been robbed of diamonds valued at some £304,590, the insurers repudiated liability on the basis of non-disclosure in respect of two material facts. First, R. had been convicted of bribing a police officer in 1946 and was fined £75. Secondly, M, the insureds’ sales manager, had been convicted of smuggling diamonds into the USA in 1956, and had

been employed by the insureds within a year of his release from prison.] McNair J: ‘In the course of time it was found that in many cases the evidence of underwriters if fully accepted would work serious hardship to assureds, particularly to dependents suing upon life policies, unless some check was imposed. Accordingly, though in some of the earlier cases to which I have been referred there are certain rather oblique references to the point, it was not until the case of Joel v Law Union and Crown Insurance [1908] 2 KB 863, that one finds in the judgment of Fletcher Moulton LJ, at p 883, a passage (which has been much debated before me and which learned Counsel for the defence submitted was wrong in law) in which the learned Lord Justice says this…: “…There is, therefore, something more than an obligation to treat the insurer honestly and frankly, and freely to tell him what the applicant thinks it is material he should know. That duty, no doubt, must be performed, but it does not suffice that the applicant should bona fide have performed it to the best of his understanding. There is the further duty that he should do it to the extent that a reasonable man would have done it; and, if he has fallen short of that by reason of his bona fide considering the matter not material, whereas the jury, as representing what a reasonable man would think, hold that it was material, he has failed in his duty, and the policy is avoided. This further duty is analogous to a duty to do an act which you undertake with reasonable care and skill, a failure to do which amounts to negligence, which is not atoned for by any amount of honesty or good intention. The disclosure must be of all you ought to have realized to be material, not of that only which you did in fact realize to be so.”

…In my judgment…the judgment of Fletcher Moulton LJ in Joel’s Case contains, if I may respectfully say so, a correct statement of the law on the topic. It has the merit…of emphasising that even under the present practice of admitting expert evidence from underwriters as to materiality, the issue as to disclosability is one which has to be determined as it was in Lord Mansfield’s day by the view of the Jury of reasonable men. …Each of [the expert] witnesses was emphatic in the view that in a jewellery insurance of this kind the moral hazard is important. Mr Archer defined the moral hazard as the risk of honesty and integrity of the assured, and, in the case of a company, the honesty and integrity of any executives or key personnel (though I think he meant the risk of dishonesty and lack of integrity). The moral hazard he considered of particular importance in the case of jewellery insurance, “because of the smallness and little weight of the jewellery and because in jewellery insurance there is often a lack of adequate documentation and jewellery is very easily disposed of.” This seems to me to be a reasonable view… Turning now to the evidence of Mr Lindley and Mr Archer as to the materiality of Mr Rosenberg’s conviction 20 years before, it is true that both these witnesses stated in plain terms that they would not have written the risk had that fact been disclosed; but they were driven in cross-examination to state such extreme views that I am unable to accept their evidence on this point. It is not necessary to cite specific examples of their extreme views. But I would mention one. Mr Archer stated that in his view a man who stole apples at the age of 17 and had lived a blameless life for 50 years is so much more likely to steal diamonds at the age of 67 that if he had told him this when putting forward a proposal at the age of 67, he would not have insured him. Many other instances of the like character can be cited from the transcript…

In the result, I have come to the conclusion that it is not established to my satisfaction that Mr Rosenberg’s offence and conviction on a matter which has no direct relation to trading as a diamond merchant was a material fact which would have influenced a prudent underwriter. Furthermore if the test be that laid down by Fletcher Moulton LJ in Joel’s Case, sup., I am satisfied beyond any doubt that a reasonable business man would not have imagined for a moment that this was a matter which the proposer should have disclosed as material. If any relevant question had been asked in the proposal form and untruthfully answered, the position would clearly be quite different. I now turn to the question of Mr Morfett’s conviction and engagement. In connection with this matter I find myself in some difficulty. Though Mr Lindley and Mr Archer and Mr Spratt gave very emphatic evidence as to their views of the materiality of this fact, no one of them gave evidence as to what their attitude would have been if they had been told the full story of Mr Morfett’s engagement and subsequent rehabilitation… As it seems to me, the position must be viewed as at the date when the 1964 insurance or possibly the 1963 insurance was put forward. Would a prudent underwriter, having heard the whole story, have declined the risk or altered the premium, or, applying the Joel test, would a reasonable man at that date have thought that this whole story was a matter which was material to be disclosed? In the course of the case and the submissions which followed it, Mr Caplan has sought to draw a distinction between smuggling goods through Customs and other offences of dishonesty…I do not imagine any reasonable person would suppose that when insuring his property against burglary he ought unasked to disclose to his underwriters that he or one of his trusted employees had on occasions brought through the Customs a bottle of brandy

without declaring it, though this may involve a criminal offence. But the matter involved here is different. Mr Morfett had been convicted of smuggling a large quantity of diamonds worth some $40,000 through the American Customs. It may be he was a mere carrier, but he was being party to a dishonest transaction. After anxious consideration of the matter in all its aspects, I have reached the conclusion and so find that the average reasonable business man, though no doubt impressed by Mr Rosenberg’s charitable act in attempting and apparently succeeding in rehabilitating a man who had paid his penalty, would appreciate that Mr Morfett remained or might remain a security risk and that underwriters should have been given the opportunity to decide for themselves whether the story as a whole was one which would have influenced them in accepting the risk as offered for fixing the premium… Though with great reluctance, in view of the conclusion I have reached as to the honesty of the claim and as to Mr Rosenberg’s charitable action towards Mr Morfett, I find that this plea of non-disclosure succeeds.’

[415] March Cabaret Club & Casino Ltd v London Assurance [1975] 1 Lloyd’s Rep 169 [The insureds, Mr and Mrs Skoulding, had effected a fire policy covering the premises of a club and restaurant owned by them. Upon renewal of the policy in April 1970, Mr Skoulding failed to disclose that he had committed the offence of dishonestly handling stolen goods in June 1969 for which he was

convicted at the Old Bailey in June 1970. He was fined £2,000.] May J: ‘Be it noted also that whereas there is a presumption that matters dealt with in a proposal form are material, there is no corresponding presumption that matters not so dealt with are not material. If any authority were required for that proposition one can find it in the case of Schoolman v Hall [above, [409]]… In the light of some of the evidence, particularly that of Mr Edmunds, I was concerned at one stage in this case about how one could reconcile the presumption of innocence and the privilege of non-incrimination with the duty of disclosure on the facts as I have outlined them. After argument I realise that my doubts were based upon a fallacy. One must remember that there is no estoppel by acquittal save as between the Crown and the person acquitted. There is nothing to prevent one party to civil proceedings, if the fact be material and relevant, attempting to prove that another party to those proceedings has in truth committed a crime of which that other party has been previously acquitted in a criminal Court. See Gray v Barr [1971] 2 QB 554 [chapter 10]…Thus, even if Mr Skoulding had been acquitted prior to the renewal in April, 1970, there would in this case have been nothing to prevent insurers attempting to prove that he had nevertheless committed the offence. If they had succeeded and if Mr Skoulding had, as here, failed to disclose that he had committed the offences, then this would, notwithstanding his acquittal, have been a material non-disclosure entitling insurers to avoid the policy. No one has a right to a contract of insurance, and if a proposer has committed a criminal offence which is material and ought to be disclosed he must disclose it, despite the presumption of innocence, which is only a presumption, and despite the

privilege of non-incrimination, which is only a privilege — or he must give up the idea of obtaining insurance at all. There is one thing, however, which I would like to add. Had it been material I would have been prepared to hold in this case that in any event Mr Skoulding ought to have disclosed the fact of his arrest, charge and committal for trial at the date of renewal, even though in truth he was innocent. What I do not agree with and would not be prepared to accept, although Mr Edmunds in his evidence sought to say to the contrary, is that if, prior to renewal, Mr Skoulding had been acquitted, there would then have been any duty on him to disclose his arrest, committal and acquittal — unless that acquittal was unjustified because he had in fact committed the offence and insurers were prepared so to allege and to prove it. To suggest that a proposer should disclose an acquittal when insurers do not propose to challenge it is in my judgment erroneous and seeks to point a path which, as at present advised, I firmly decline to tread.’

[416] Lambert v Co-operative Insurance Society [1975] 2 Lloyd’s Rep 465 (CA) [In April 1963 the insured effected an “All Risks” policy covering her own and her husband’s jewellery. At this time she was not asked and did not disclose her husband’s conviction some years earlier for receiving stolen cigarettes for which he was fined £25.00. The policy contained a condition which provided that it would be ipso facto void if there was non-disclosure of a material fact. The policy was renewed each year. In December 1971 the insured’s husband was again convicted for offences involving dishonesty and sentenced to a prison term. This was

not disclosed at the next renewal. In April 1972 the insured claimed for lost or stolen items of jewellery. The insurers repudiated liability]. Cairns LJ: ‘I too would dismiss this appeal. While Mr Lewis has been able to refer to a number of judgments…in which the language suggested that it is only what a reasonable proposer would consider relevant that has to be disclosed, I do not think that in any of those cases the Judges were directing their minds to the problem of whether the test is the mind of a reasonable proposer or that of a reasonable underwriter. They were concerned to dismiss the contention that only the facts which the proposer considered material need be disclosed. One strong pointer to its being the view of a reasonable underwriter which is relevant is that it has for long been the practice, as was said by McNair J in Roselodge Ltd v Castle, at p 129, for evidence to be admitted of underwriters as to what they would consider relevant. If the question were what a reasonable member of the public would consider material, such evidence would not be relevant and it is difficult to see that any expert evidence would be admissible… In providing by statute that the test should be that of the insurer in marine insurance cases, I think that Parliament was doing no more than inserting in its code of marine insurance law what it regarded as the general rule of all insurance law…’

[417] Strive Shipping Corp v Hellenic Mutual War Risks Association (Bermuda) Ltd (The Grecia Express) [2002] 2 Lloyd’s Rep 88 [The facts are immaterial].

Colman J: ‘In my judgment, it is quite clear from section 18 of the Marine Insurance Act, 1906 that the attribute of materiality of a given circumstance has to be tested at the time of the placing of the risk and by reference to the impact which it would then have on the mind of a prudent insurer. In this connection it is for present purposes necessary to distinguish between three types of circumstances: (1) allegations of criminality or misconduct going to moral hazard which had been made by the authorities or third persons against the proposer and are known to him to be groundless; (2) circumstances involving the proposer or his property or affairs which may to all outward appearances raise a suspicion that he has been involved in criminal activity or misconduct going to moral hazard but which he knows not to be the case; (3) circumstances involving him or his business or his property which reasonably suggest that the magnitude of the proposed risk may be greater than what it would have been without such circumstances. As to case (1), if an allegation of criminal conduct has been made against an assured but is as yet unresolved at the time of placing the risk and the evidence is that the allegation would have influenced the judgment of a prudent insurer, the fact the allegation is unfounded cannot divest the circumstance of the allegation of the attribute of materiality. For example, if the proposer had told the insurer of the allegation and also that it was unfounded, the insurer might well have preferred not to trust the word of the assured or might have preferred to conduct his own investigation before agreeing to underwrite the risk. As to case (2), it is, in my judgment, quite unrealistic for underwriters to require disclosure of facts, which the proposer knows to have no bearing on his honesty or integrity, on the basis that a suspicious person when told of

those facts might believe that it did have such a bearing. Unlike case 1 where a third party has made a specific allegation against the proposed assured, case 2 involves that the assured should evaluate for himself perfectly innocent facts to see whether they might be misconstrued by an underwriter as indicating his dishonesty. I do not consider that the duty of the utmost good faith involves as rigorous an approach as this. Nor, indeed, did the [insurers’] expert, Mr Hunt…Provided that there has been no outward allegation material to the proposer’s integrity and that he is in truth innocent, the mere suspiciousness of the facts does not render them disclosable. As to case (3) by parity of reasoning, if the assured knows of facts which, when viewed objectively, suggest on the face of it that facts might exist (“the suggested facts”) which would increase the magnitude of the risk and the known facts would have influenced the judgment of a prudent insurer, the known facts do not cease to be material because it may ultimately be demonstrated that the suggested facts did not exist. That which invests the circumstances with materiality is emphatically not the existence of the suggested facts, but the existence of the known facts, for the underwriter is entitled to take into account the risk that the suggested facts may be true and the proposer is not entitled to deprive the underwriter of that opportunity because he personally believes albeit he does not know for certain that the suggested facts are untrue… However, the authorities suggest that the rumours have to have at least some real substance and reliability when objectively viewed. Thus, in Durrell v Bederley, (1816) Holt NP 283 in the Court of Common Pleas at Nisi Prius…Gibbs LJ concluded…: “The question is, did the plaintiff know any facts injurious to the adventure, which ought, in common honesty, to have

been communicated to the underwriters; I mean substantial facts, which were likely to change their opinion as to the magnitude of the risk. Loose rumours which have gathered together, no one knows how, need not be communicated. Intelligence, properly so called, and as it is understood by mercantile men, ought to be disclosed when known. The materiality of the facts known and suppressed are for the decision of the jury. If the concealment be of a material fact, whether a rumour, report or an article of intelligence, it ought to be communicated; if immaterial, it may be withholden.” …That, however, is far from being the end of the matter. I refer at the outset to the judgment of Staughton LJ in Kausar v Eagle Star Insurance Co Ltd [2000] Lloyd’s Rep IR 154 at p 157: “Avoidance for non-disclosure is a drastic remedy. It enables the insurer to disclaim liability after, and not before, he has discovered that the risk turns out to be a bad one; it leaves the insured without the protection which he thought he had contracted and paid for. Of course there are occasions where a dishonest insured meets his just deserts if his insurance is avoided; and the insurer is justly relieved of liability. I do not say that non-disclosure operates only in cases of dishonesty. But I do consider that there should be some restraint in the operation of the doctrine. Avoidance for honest non-disclosure should be confined to plain cases.” However, one should not lose sight of the fact that were the evidence before the Court, upon which underwriters rely to avoid the policy, to establish that, although the known facts were not disclosed, the suggested facts did not in truth exist, underwriters would be seeking to avoid liability in respect of a risk which, had they been in possession of the

true facts, as distinct from the allegations of suggested facts, they would have written without hesitation. In so doing they would, in effect, be utilising loss of the opportunity of forming an unfounded suspicion of nonexistent facts in order to avoid paying a loss under a policy which, had the truth been made known to them when they wrote the risk, they would not have hesitated to underwrite. To persist in such a course in the face of evidence before the Court that the suggested facts never existed would, in my judgment, be quite contrary to their duty of the utmost good faith. Such a course would be so starkly unjust that I would hold that in such a case it would be unconscionable for the Court to permit the insurers to avoid the policy on the grounds of nondisclosure. Having regard to the equitable origin of the jurisdiction to avoid a policy for breach by the assured of the duty of the utmost good faith, the Court should not be inhibited from giving effect by appropriate orders to the insurers’ countervailing duty of the utmost good faith to the assured. The breach of that duty by the insurers would be so unconscionable as to disentitle the insurers from invoking the equitable jurisdiction of the Court to avoid the contract on the grounds of non-disclosure by the assured. The procedural and evidential consequences which flow from this conclusion are, in my judgment, as follows: (1) In the field of moral hazard, a failure by the assured to disclose an existing allegation against him of dishonesty or relevant criminal conduct or a criminal charge will normally be nondisclosure of a material fact which prima facie entitles the insurer to avoid the policy. (2) If, in proceedings in which the insurer seeks to avoid the policy for such non-disclosure, the assured proves that the allegation or charge was unfounded and that there has been no dishonesty or criminal conduct on his part, the insurers will not normally be entitled to

avoid the policy. For example, where the assured has been charged with a criminal offence and subsequently acquitted at a trial, he can deploy his acquittal as some evidence, but not conclusive evidence, of his innocence. Similarly, if he has been charged but not yet convicted, he can prove his innocence in order to displace the entitlement of the insurers to avoid for his failure to disclose the charge against him. (3) If I am wrong in concluding that an assured is under no duty to disclose facts merely because they are objectively suspicious as to his own wrong-doing when he knows that the suggested facts do not exist, it must by parity of reasoning be open to the assured to displace the underwriters’ entitlement to avoid for non-disclosure of circumstances because they are objectively suspicious by proving that the suspicion was misplaced and that the facts of the existence of which there was suspicion never in truth existed. (4) If the facts objectively raise suspicions going to the magnitude of the risk, the assured is under a duty to disclose them but if at the trial he establishes that there was in truth no basis for those suspicions it is not open to the insurers to invoke the Court’s equitable jurisdiction to avoid the policy.’

Notes: 1. Thus, following March Cabaret Club Colman J held that outstanding criminal charges and acquittals are to be viewed as material facts (see also, Inversiones Manria SA v Sphere Drake Insurance Co plc, The Dora [1989] 1 Lloyd’s Rep 69).

2.

Colman J’s reasoning was subjected to considerable scrutiny by the Court of Appeal in Brotherton v Aseguradoa Colseguros SA [2003] EWCA Civ 705. Columbian media reports carried allegations of serious misconduct and related investigations involving the business activities of the Columbian reinsureds that had not been disclosed by them. The issue in this appeal by the reinsureds from the decision of Moore-Brick J concerned the question of whether the materiality of the media reports and the validity of the avoidance by the reinsurers on the basis of non-disclosure depended upon the correctness of the allegations. The appeal was heard before the trial set for determining whether there was in fact misconduct. Mance LJ drew the distinction between material intelligence that might ultimately be demonstrated as unfounded but which should nevertheless be disclosed and immaterial idle rumours which need not be disclosed by an insured or his or her agent (citing Lynch v Hamilton (1810) 3 Taunt 15, Lord Ellenborough CJ). Significantly, Mance LJ disagreed with Colman J’s analysis in The Grecia Express (above, [417]) that avoidance is an equitable remedy that is, therefore, discretionary. Colman J had taken the view that where insurers who have avoided a policy subsequently learn, say at the trial, that the non-disclosed fact was not actually material they may be held to be in breach of their own

duty of utmost good faith on the basis of their inequitable behaviour. The Court of Appeal in Brotherton rejected this reasoning on the basis that the right to avoid was a self-help remedy that could be exercised without the court’s authorisation. Thus, avoidance which can be justified at the time the remedy was exercised by (re-)insurers cannot subsequently be challenged. Mance LJ: ‘…I cannot see that the decision in Pan Atlantic that avoidance depends on inducement as well as materiality lends support to a conclusion that avoidance for nondisclosure of otherwise material information should depend upon the correctness of such information, to be ascertained if in issue by trial. In my judgment, neither principle nor sound policy supports such a conclusion. The assumed starting point is that an insurance has actually been induced by the nondisclosure of matters within an insured’s knowledge which would have influenced the judgment of a prudent insurer. Had the insured made the disclosure which Colman J himself accepts should have been made, the insurance would either not have been written at all, or it would have been written on different terms (including as to premium), and the insured could not done anything about this in either case by later showing the incorrectness of any material intelligence which induced the insurer to refuse the insurance or to insist on more stringent terms. Moreover, had due disclosure been made, there would have been no call for any subsequent investigation or litigation about the correctness or otherwise of the intelligence. The insured has failed to make the disclosure he should have made. That carries with it the risk that underwriters would never learn of the intelligence at

all, and never realise that there was anything to investigate… Further, if no disclosure was made, and underwriters did discover the intelligence later, then on Mr Millett’s case [counsel for the reinsureds] the matter does not end there. The position is not restored to that which would have applied, had there been timely, pre-contractual disclosure. On the contrary, underwriters are bound to be prepared to investigate and litigate what might in some cases, and certainly would in the present case, be matters of the most difficult and sensitive nature, both from an evidential and from a substantive viewpoint. In some cases it is possible (as Colman J suggested in The Grecia Express [above, [417]]) that underwriters might have conducted some form of pre-placement investigation of intelligence, if it had been disclosed to them. But it is implausible to think that this would compare with the investigation which would occur prior to and at trial of an issue finally to determine the correctness of such intelligence. The present case illustrates this implausibility. A very substantial public enquiry or trial would probably be necessary to form any definite view as to the correctness of allegations like those reported in the Columbian media and the subject of the Columbian investigations. In summary, it would be an unsound step to introduce into English law a principle of law which would enable an insured either not to disclose intelligence which a prudent insurer would regard as material or subsequently to resist avoidance by insisting on a trial, in circumstances where: i) if insurers never found out about the intelligence, the insured would face no problem in recovering for any losses which arose — however directly relevant the intelligence was to the perils insured and (quite possibly) to the losses actually occurring; and ii) if insurers found out about the intelligence, then (a) they would in the interests of their syndicate members or

shareholders have normally to investigate its correctness, and (b) the insured would be entitled to put its insurers to the trouble, expense and (using the word deliberately) risk of expensive litigation, and perhaps force a settlement, in circumstances when insurers would never have been exposed to any of this, had the insured performed its prima facie duty to make timely disclosure… If, as I consider, both the second and the third strands of the reasoning in The Grecia Express are unsound, that is the end of this appeal. Unless the reinsureds are entitled to a trial to determine whether there was any actual misconduct justifying the allegations and investigations relating to the original insured and its officers, the only relevant issues for trial are…[(i) whether, as at the time of the placements in November 1997 (or, as the case may be, the extensions in November 1998), the reports (or the reports coupled with the fact of the investigations) were or ought to have been known either to the reinsureds or to all or any of the reinsurers; (ii) whether, at that time, their mere existence constituted a matter which a prudent reinsurer would have regarded it as material to know. On that issue expert underwriting evidence will, in accordance with modern practice, be admissible; the issue will raise for consideration whether the reports (or the reports and investigations) amounted to intelligence, or were mere “loose” or “idle” rumours; (iii) whether, if the actual reinsurers had known of the reports (or the reports and investigations) at that time, such knowledge would have induced all or any of them to act differently, either by not entering into (or extending) the reinsurances, or by only doing so on different terms (including a different rate); some light may be thrown on this by the answer to (ii), but the evidence of the actual reinsurers is likely to be more important]. Absent such a trial and determination, there can be no conceivable basis for complaining about reinsurers’ avoidance for non-disclosure

of the reports (or the reports and investigations), assuming that such matters are shown at trial to have been material and to have induced reinsurers in the sense identified in Pan Atlantic… However, I add some further words on the first strand. Firstly, rescission under English law is not generally subject to any requirement of good faith or conscionability. It is unnecessary to address the academic chestnut, delicately handled by Lord Mustill in Pan Atlantic at p 544, of the juristic origin of the duty of disclosure in insurance law, in particular whether or to what extent the origin is equitable and what role the common law played: cf Carter v Boehm. The mere fact that a right to rescind has an equitable origin does not mean that its exercise is only possible if that is consistent with good faith or with a court’s view of what is “conscionable”. Secondly, recent authority has in any event tended to limit the scope of any post-contractual duty of good faith to circumstances of repudiatory breach or fraudulent intent: cf The Star Sea [above, [425]]; The Mercandian Continent [see chapter 11, [1103]]; The Aegeon [2002] EWCA Civ 247 [see chapter 11]…’ For the reasons I have given, I consider that Moore-Bick J’s judgment, with which I agree in its entirety, was correct, and that this appeal fails.’

Notes: 1. By virtue of section 4(3) of the Rehabilitation of Offenders Act 1974 an insured is under no duty to disclose a “spent” conviction. A conviction which carries a sentence of two and a half years imprisonment or more can never become spent. Convictions that carry custodial sentences of less than six months become spent after seven years and those that carry

sentences of between six months and two and a half years become spent after ten years. 2. Where a conviction is “spent”, section 4(2) of the Act provides that any question in a proposal form regarding previous convictions is to be treated as not referring to such a conviction. However, section 7(3) of the Act confers a discretion on the court to admit evidence as to spent convictions if the court is satisfied that “justice cannot be done in the case except by admitting it.” [418] Reynolds v Phoenix Assurance Co [1978] 2 Lloyd’s Rep 440 [(See also, above [412] and chapter 13, [1304]). A further issue in this case was whether the insured’s conviction in 1961 for receiving stolen goods was a material fact that should have been disclosed when effecting the fire policy in 1972. The insurers argued, inter alia, that under section 7 of the Rehabilitation of Offenders Act, 1974, the judge had a discretion whether or not to admit the conviction]. Forbes J: ‘The receiving offence …It is an offence of dishonesty. There are only two factors which it seems to me to require consideration, first the extent of the dishonesty and secondly the age of the conviction; as I have indicated this appeared to be the general view of most of the [expert] witnesses… …I can find no special facts in this case to cause me to change my first impression which was similar to that of Lord

Pearson, with this added fact that the conviction only resulted in a fine, the size of which might quite properly have been designed to reflect not the gravity of the offence but the fact that Mr Reynolds was a man of considerable means. Nor is there any unanimity among the experts. I conclude that the defendants have failed to prove to my satisfaction that this particular conviction 11 years previously was a material fact which would have affected the judgment of a reasonable or prudent insurer in fixing the premium or determining whether he will take the risk.

The Rehabilitation of Offenders Act, 1974 In view of the conclusion to which I have come about the materiality of the conviction it is probably unnecessary for me to consider the position under the 1974 Act. However I feel that I should indicate the course I would have taken had I decided that the conviction was a material fact which should have been disclosed. This is because, it seems to me, that the terms in which the discretion to admit evidence concerning a spent conviction is given by the Statute are such that it is virtually incumbent upon a Judge of first instance to pass upon this matter. The relevant provision is section7(3) of the 1974 Act. So far as is material it is in these terms: “…If at any stage in any proceedings before a judicial authority in Great Britain — the authority is satisfied in the light of any considerations which appear to it to be relevant including any evidence which has been or may thereafter be put before it that justice cannot be done in the case except by admitting or requiring evidence relating to a persons spent convictions or to circumstances ancillary thereto, that authority may admit or as the case may be require the evidence in question notwithstanding the provisions of subsection 1 of section 4 above and may determine any issue

to which the evidence relates in disregard, so far as necessary, of those provisions.” The provisions of section 4(1) are those which prohibit the giving of evidence relating to a spent conviction or the fact that the person so convicted committed the offence with which he had been charged. It is the reference to the evidence which I have emphasised in section 7(3) which seems to me to make it incumbent upon a Judge of first instance to deal with this matter. Had I considered that the defendants had proved that the conviction was a material fact it would have been because I would have accepted the evidence of those of the expert witnesses who maintained that the conviction was material. This in its turn would be because I accepted that it was the general practice among insurance companies to require such matters to be disclosed, to consider themselves entitled to refuse cover in such circumstances, and, and this is important, to avoid a policy on the ground of material non-disclosure in cases where no such disclosure was made. It would be against that background that I would have had to have judged whether or not I was satisfied that justice could not be done in the case except by admitting or requiring evidence of the spent conviction. It seems to me on those hypotheses that there is really only one conclusion to which I could have come. If the universal practice of insurance companies would involve the probable refusal of cover if the fact of a previous conviction had been disclosed, and in this case a material conviction was not so disclosed, then there would be no real injustice to the plaintiffs in requiring the conviction to be disclosed now because on this view they were bound to disclose it in 1972, did not do so, and therefore obtained a policy which otherwise they would probably never have obtained. On the defendants’ side on the other hand there would be the gravest injustice because they would be prevented from avoiding a policy, which on

this view of the evidence, it would be the universal practice of insurers to avoid in such circumstances, and would be bound to pay insurance moneys on a policy relating to a risk which, again on this view of the evidence, they would, by universal practice, have been entitled to decline.’

Insurance history: prior refusals and claims record [419] Glicksman v Lancashire and General Assurance Co Ltd [1927] AC 139 (HL) [The facts appear from Viscount Dunedin’s speech]. Viscount Dunedin: ‘My Lords, one Sapsy Glicksman, a small ladies’ tailor, insured against burglary his Stock in trade. A burglary happened and a large portion of his stock in trade was taken away, but upon his applying to the insurance company for the insurance money he was met by the allegation that there had been no burglary and no stock in trade. They went to arbitration, and here is what the learned arbitrator said: “On the hearing of the reference during the opening of the case for the claimant, counsel for the respondents stated to me that the only point he intended to raise was that there had been no burglary as alleged by the claimant and that the goods for which the claim was made were not upon the said premises at the date of such alleged burglary and had not been removed or stolen by burglars as alleged.” That was a very serious accusation. It was an accusation which, if it were true, would have put the man in prison…Here is what the arbitrator said about it: “I find that the goods in respect of which the claim was made were upon the said premises at such date and were stolen and removed by burglars as alleged by the claimant, and that the claimant thereby suffered loss and damage to the

amount of £1,656. 6s 3d.” But, in the course of the examination of the claimant, in answer to some more or less casual questions, it seems that he said that he had been turned down by another office, and thereupon the insurance company remembered that he had, like other people, signed a paper when he made application for insurance, and accordingly they asked leave and got leave to put in an amended point of defence. The amended point of defence was: “It was warranted by the policy that the statements made by the applicant in his proposal in writing dated 9 November 1922, were true in all respects, and that if the policy should be obtained through any misrepresentation, suppression, concealment, or untrue averment” it should be absolutely void. Then it was said that he had, as a matter of fact, in answer to a question: “Has any company declined to accept or refused to renew your burglary insurance? “said: “Yorkshire accepted, but proposers refused on account of fire proposal”; whereas, in fact, in a written proposal dated 19 June 1919, the applicant had offered his burglary insurance to the Sun Insurance Office and the said Sun Insurance Office had declined it. It was not quite plain sailing even then, because when the proposal came to be looked at it was found that at the time the proposal was made he was in partnership. The word “you “in English in either singular or plural, and when you come to the answers to the questions there is, what I may call, a somewhat inextricable confusion between the singular and the plural. Of course, literally speaking, if the word “you “is used in the plural, as naturally it should have been because two people were applying, then it was quite true that there had not been any refusal of an insurance; but it was not true if you take it in the singular. The arbitrator came to the conclusion that it voided the policy and an appeal was taken on a stated case to Roche J Roche J came to an opposite conclusion…

My Lords, for the reasons that I shall presently state, I am unable to agree with Roche J…I come to the law of it. The law has often been stated, but perhaps it is just as well to state it again. A contract of insurance is denominated a contract uberrimae fidei. It is possible for persons to stipulate that answers to certain questions shall be the basis of the insurance, and if that is done then there is no question as to materiality left, because the persons have contracted that there should be materiality in those questions; but quite apart from that, and alongside of that, there is the duty of no concealment of any consideration which would affect the mind of the ordinary prudent man in accepting the risk. Now, as I have said, upon this proposal two questions arose. First, the question arose upon what I call the plural and the singular. One of the learned judges in the Court of Appeal has said that he would like further to consider this. Roche J decided it in the sense that the question was really put in the plural, and that therefore there was no untrue answer. There were certain cases quoted to us which go to the same view. Two of the learned judges in the Court of Appeal took the other view…But here the whole point really comes to turn upon this — and this is the ground of the judgment of the learned judges in the Court of Appeal — that, never minding the singular or the plural, the fact that a question of this sort was put showed that the insurance company thought it was material whether a proposal had been refused or not, and that that was brought to the knowledge of the claimant. My Lords, under the circumstances I have considerable doubts, but then I am not entitled to take any view of my own on that, because that is a fact and the arbitrator has found it as a fact and I cannot get beyond the arbitrator’s finding, I think that the reasoning of the learned judges in the Court of Appeal is impeccable. This was brought to the knowledge of the claimant that it was a material fact, and he certainly did not disclose it, and, therefore, the policy is void.

Therefore, my Lords, with unfeigned regret, I move your Lordships that this appeal be dismissed with such costs as there are in a case in forma pauperis.’

Lord Wrenbury: ‘My Lords, it is with the very greatest reluctance that I concur in the motion which is proposed from the Woolsack. I think it a mean and contemptible policy on the part of an insurance company that it should take the premiums and then refuse to pay upon a ground which no one says was really material. Here, upon purely technical grounds, they, having in point of fact not been deceived in any material particular, avail themselves of what seems to me the contemptible defence that, although they have taken the premiums, they are protected from paying.’

[420] Locker and Woolf Ltd v Western Australian Insurance Co Ltd [1936] 1 KB 408 (CA) [In a proposal for fire insurance, the insured, in answer to the question: “Has this or any other insurance of yours been declined by any other company?” answered “No.” A fire occurred at the premises and the insurers repudiated liability. Two years prior to effecting the fire policy, the insured had been declined motor insurance on the grounds of misrepresentation and non-disclosure]. Slesser LJ: ‘It is elementary that one of the matters to be considered by an insurance company in entering into contractual relations with a proposed insurer is the question of the moral integrity of the proposer — what has been called the moral hazard. In the present case it is quite impossible to say that the non-

disclosure by those proposing to take out a policy against fire risks that they have had an insurance on motors declined on the ground of untrue answers in the proposal form is not the non-disclosure of a fact very material for the insurance company to know — a fact which if known to the company might lead them to take the view that the proposers were undesirable persons with whom to have contractual relations. In those circumstances there can, in my opinion, be no doubt that on the general law of insurance the company were perfectly entitled to repudiate the contract on the ground of the non-disclosure of a material fact.’

[421] London Assurance v Mansel (1879) 41 LT 225 (CA) [In a proposal for life assurance the insured, in answer to the question, “Has a proposal ever been made on your life at any other office or offices? If so, where? Was it accepted at the ordinary premium, or at an increased premium, or declined?” answered “Insured now in two offices for £16,000 at ordinary rates. Policies effected last year.” At the foot of the proposal the insured signed the following declaration: “I declare that the above written particulars are true, and I agree that this proposal and declaration shall be the basis of the contract between me and the London Assurance.” In fact five life companies had declined him cover notwithstanding that he had passed the medical examinations]. Jessel MR: ‘The first question to be decided is, what is the principle on which the Court acts in setting aside contracts of

assurance? As regards the general principle I am not prepared to lay down the law as making any difference in substance between one contract of assurance and another. Whether it is life, or fire, or marine assurance, I take it good faith is required in all cases, and, though there may be certain circumstances from the peculiar nature of marine insurance which require to be disclosed, and which do not apply to other contracts of insurance, that is rather, in my opinion, an illustration of the application of the principle than a distinction in principle… Now I come to the facts of the case, which certainly appear to me to be very plain and clear indeed…The question was, “Has a proposal been made at any office or offices; if so, where?” He does not state, “I proposed to half a dozen offices,” which was the truth, but simply says, “Insured now in two offices,” which of course must have been intended to represent an answer, and therefore would mislead the persons receiving it, who did not look at it with the greatest attention, into the belief that he was insured in two offices, and that they were the only proposals that he had made. “Was it accepted at the ordinary premiums or an increased premium?” His answer is, “At ordinary rates.” That is the answer to the second branch of the inquiry, but he has not answered the question, “or declined?” The inference, therefore, which must have been intended to be produced on the mind of the person reading the answer was that it had not been declined. And in my opinion that is the fair meaning of the answer; and the assured is not to be allowed to say, “I did not answer the question.” But if it were so it would make no difference, because if a man purposely avoids answering a question, and thereby does not state a fact which it is his duty to communicate, that is concealment. Concealment properly so called means nondisclosure of a fact which it is a man’s duty to disclose, and it was his duty to disclose the fact if it was a material fact.

The question is whether this is a material fact? I should say, no human being acquainted with the practice of companies or of insurance societies or underwriters could doubt for a moment that it is a fact of great materiality, a fact upon which the offices place great reliance. They always want to know what other offices have done with respect to the lives…We have an admission by the Defendant that no less than five insurance offices had declined to accept his life. Now, to suppose that any one who knows anything about life insurance, that any decent special juryman could for a moment hesitate as to the proper answer to be given to the inquiry, when you go to the insurance office and ask for an insurance on your life, ought you to tell them that your proposals had been declined by five other assurance offices? is, I say, quite out of the question. There can be but one answer — that a man is bound to say, “My proposals have been declined by five other offices. I will give you the reasons, and shew you that it does not affect my life,” as he admits it to be by this answer; but of that the office could judge. There can be no doubt, as a proposition to be decided by a jury, that such a circumstance is material. But in fact I have elements here admitted on the pleadings for deciding that question quite irrespective of the ordinary knowledge of the practice of mankind in respect of these matters which is to be imputed to a good special juryman, because I have here two things admitted, first of all that the proposal which forms the basis of the contract asks a question — Has a proposal been declined? …So here we have the proposal as the basis of the contract. It is impossible for the assured to say that the question asked is not a material question to be answered, and that the fact which the answer would bring out is not a material fact.’

Notes: Given the all or nothing consequences of nondisclosure, the Insurance Ombudsman may require the insurers in consumer insurance to pay a proportion of a claim based on the difference between the actual premium charged and the premium which would have been charged had the material fact been disclosed. [422] Insurance Ombudsman Bureau Digest ‘All or nothing’ decisions are not always fair

Proportionality Insurance policies tend to be printed in black and white. Even if colours are introduced on the printed page for added emphasis, the objective of those who draft the policies tends to remain the same…Either the claim will succeed, and the policyholder will be paid in full: or the claim will fail and the policyholder will receive nothing. In the Bureau, we sometimes have to ask whether such an approach leads to a fair and reasonable solution. We introduced the principle of proportionality to deal with case of unintentional non-disclosure and misrepresentation (Annual Report for 1989 para 2.16–7). The Annual Report for 1994 (para 2.10), we illustrated how we have been applying a principle of proportionality to deal with the interplay of pre-existing medical conditions and accidental injuries in the case of personal accident policies covering permanent and temporary total disability… Limits of proportionality ‘Splitting it down the middle’ works well in some insurance disputes, but we have to ensure that it does not become a

cop-out from making a difficult decision in others… Something less than all will be quite unfair if the policyholder is entitled to his claim in full, or if the insurer has reasonable grounds for declining to make any payment whatsoever. Adopting a proportionate solution must involve no less an exercise of judgement than deciding one way or the other. In a claim under a travel policy, raising this issue, the balance went in favour of the insurer. A provision in the policy entitled the policyholder to payment of £30,000 in the event of an accident resulting in total permanent disability. We decided that this did not entitle the policyholder to payment of 50 per cent in the event of an accident resulting in partial total disability. Similarly, in such policies, the provision that a delay in departure of more than 12 hours will entitle the policyholder to a payment of £20 does not mean that in the event of a delay of only six hours the policyholder will be entitled to £10. A case involving permanent health insurance shows the balance going in favour of the policyholder. The policy defined incapacity as: “the total inability of the Insured, by reason of sickness or injury, to follow his Occupation.” The policyholder had suffered from crippling anxiety and depression. Initially, the insurer was willing to meet his claim, and for two years it continued to do so. In 1994 the policyholder’s condition began to improve, and the insurer stopped payments on the basis that the policyholder was now fit to go back to work. His doctors did not agree. The problem was the nature of the work. The policyholder had been an “Insurance Inspector” or, less euphemistically, a salesman. His employer said that he was “too much of a perfectionist, which hampers him in the demanding occupation of selling life insurance.” The PHI insurer said that this showed that the policyholder was not disabled by any reasonable standards. It suggested that a salesman in the policyholder’s condition, but with a more realistic approach,

would be quite well enough to sell life insurance. As we deal in the Bureau will continual complaints about life insurance salesmen whose standards are too low, rather than too high, we could not help noting this unusual turnaround. The case itself, of course, had to be determined on objective grounds. In the end, the medical evidence was conclusive. A consultant psychiatrist confirmed that the policyholder was not totally incapacitated. He could do some work. But he was not fit to resume his former occupation as an insurance salesman ‘because it is probably a very stressful job which requires robust ability to cope with the world’s demands and rebuffs’. If the policyholder could do some work, why not give him a proportion of the benefit? This would not have been fair to him. He was insured against incapacity to do his job. The medical evidence showed that he was not fit to cope with the essential demands of the job. That was the substance of the matter. After further considerations, and some straight talking from the Bureau, the insurer agreed to go on paying full benefit under the policy until it was due to terminate in 1998 [AR (95) para 2.5.5 p 39–41]… IOB Annual Report 1994 (vii) Where the insurer’s underwriting guide or other evidence satisfies me that the facts withheld or misrepresented would have had a bearing on the premium or acceptance of risk, I may apply the principle of proportionality. This involves my requiring the same proportion of the claim to be met as the premium paid…if the premium would have been loaded by 50 per cent, my award will be two-thirds of the amount otherwise payable. The House of Lords confirmed that so far as the common law is concerned the principle of proportionality has no application in these cases, but dicta suggest that it may not be inappropriate in the field of consumer insurance. The

observations on this point of Sir Donald Nicholls VC in the Court of Appeal in Pan Atlantic were not disapproved of in the House of Lords [above, [405]]. He made a strong indictment of the harshness of the ‘all or nothing’ result of the English common law rules, and provided an affirmation of the essential fairness of the principle of proportionality in appropriate cases.’

4.1.7 The Conceptual Basis of the Doctrine of Utmost Good Faith The scope and conceptual basis of the disclosure duty has given rise to considerable judicial debate particularly in relation to moral hazard. The question can be put simply: is the duty based upon an implied term of the contract, or does it rest upon a fiduciary relationship or a duty in tort? [423] March Cabaret Club & Casino Ltd v London Assurance [1975] 1 Lloyd’sRep 169 [The facts are set out above, [415]]. May J: ‘Even the common law duty of disclosure I find difficult to explain fully on the theory of its resting only on an implied term of the contract. If it did, it would not arise until the contract had been made; and then its sole operation would be to unmake the contract. Although the question has not been decided judicially, it is worthy of note that sections 17 and 18 of the Marine Insurance Act 1906 seem to treat the twin duties of

disclosing all the material facts, and of misrepresenting none, as existing outside the contract, and not as mere implications inside the contract; for that Act was intended to be declaratory of the common law; and I see nothing in the language of these particular sections to justify interpreting them as being anything but declaratory…’

[424] Banque Keyser Ullmann SA v Skandia Insurance Co [1990] 1 QB 665 (CA) [The facts are summarised below, [426]: Banque Finanière de la Cité Sa v Westgate Insurance Co Ltd [1991] 2 AC 249. The issue here concerned the scope of the disclosure duty borne by insurers and the remedy available to the insured for its breach]. Slade LJ ‘If, however, this obligation does not arise under contract or statute and no fiduciary relationship between the parties is asserted, a breach of the obligation must, in our judgment, itself constitute a tort if it is such as to give rise to a claim for damages. There is no authority whatever to support the existence of such a tort and, quite apart from such lack of authority, there are in our judgment at least four reasons why this court should not by its present decision create a novel tort of this nature. First, the powers of the court to grant relief where there has been non-disclosure of material facts in the case of a contract uberrimae fidei stems from the jurisdiction originally exercised by the courts of equity to prevent imposition. The powers of the court to grant relief by way of rescission of a contract where there has been undue influence or duress stem from the same jurisdiction. Since duress and undue influence as such give rise to no claim for

damages, we see no reason in principle why non-disclosure as such should do so. Secondly, the decision in CTI [see above, [403]] establishes that where an underwriter is seeking the conventional remedy of avoidance of the policy, the actual effect of the nondisclosure on his mind is irrelevant…The same approach must, in our judgment, apply in a case where an insured is seeking avoidance of the policy. The court will be concerned not so much with the effect of the non-disclosure on his mind as that of the mind of a prudent notional insured in his position. Steyn J rightly recognised the difficulties involved in translating this approach to a case where the insured is seeking damages. He said… Assuming therefore that…the test is the effect on the notional insured only, it could legitimately be asked how damages could be awarded if the non-disclosure had no effect on the insured. In my judgment the only conceivable answer is that the requirements for avoidance are less than for an action for damages. We agree that this is the only conceivable answer, but think that the problem posed by the judge is another illustration of the conceptual difficulties involved in a decision that a remedy by way of damages lies in this class of case. Thirdly, section 17 of the Act of 1906, which imposes reciprocal obligations of good faith on both parties to such a contract, specifically gives the injured party the remedy of avoidance of the contract (and no other remedy). Likewise, section 18, which specifically defines the duty of disclosure falling upon the assured, concludes by stating the insurer’s remedy as follows: “If the assured fails to make such disclosure, the insurer may avoid the contract.” There is not a suggestion in any of the succeeding provisions of the Act of 1906 that a breach of the obligation of good faith will, as such, give rise to a claim for damages…

[W]e think the clear inference from the Act of 1906 is that Parliament did not contemplate that a breach of the obligation would give rise to a claim for damages in the case of such contracts. Otherwise it would surely have said so. It is not suggested that a remedy is available in the case of non-marine policies which would not be available in the case of marine policies. Fourthly…in the case of a contract uberrimae fidei, the obligation to disclose a known material fact is an absolute one. It attaches with equal force whether the failure is attributable to “fraud, carelessness, inadvertence, indifference, mistake, error of judgment or even to [the] failure to appreciate its materiality”: see ER Hardy Ivamy, General Principles of Insurance Law, 5th edn (1986), p 156 and the cases there cited. A decision that the breach of such an obligation in every case and by itself constituted a tort if it caused damage could give rise to great potential hardship to insurers and even more, perhaps, to insured persons. An insured who had in complete innocence failed to disclose a material fact when making an insurance proposal might find himself subsequently faced with a claim by the insurer for a substantially increased premium by way of damages before any event had occurred which gave rise to a claim. In many cases warranties given by the insured in the proposal form as to the truth of the statements made by him might afford the insurers the same remedy, but by no means in all cases. In our judgment, it would not be right for this court by way of judicial legislation to create a new tort, effectively of absolute liability, which could expose either party to an insurance contract to a claim for substantial damages in the absence of any blameworthy conduct.’

[425] Manifest Shipping Co Ltd v Uni-Polaris Shipping Co Ltd (The Star Sea) [2001] 2 WLR 170 (HL)

[For the facts and another part of this decision, see chapter 11]. Lord Hobhouse: ‘Section 17: The legal problems Section 17 raises many questions…[it] is overlaid by the historical and pragmatic development of the relevant concept both before and since 1906. The history of the concept of good faith in relation to the law of insurance is reviewed in the speech of Lord Mustill in Pan Atlantic Insurance Co v Pine Top Insurance Co [above, [405]], and in a valuable and well researched article (also containing a penetrating discussion of the conceptual difficulties) by Mr Howard Bennett in [1999] LMCLQ 165 [see chapter 11, [1101]]. The acknowledged origin is Lord Mansfield’s judgment in Carter v Boehm [above, [402]]. As Lord Mustill points out, Lord Mansfield was at the time attempting to introduce into English commercial law a general principle of good faith, an attempt which was ultimately unsuccessful and only survived for limited classes of transactions, one of which was insurance. His judgment in Carter v Boehm was an application of his general principle to the making of a contract of insurance. It was based upon the inequality of information as between the proposer and the underwriter and the character of insurance as a contract upon a “speculation”. He equated non-disclosure to fraud. He said at p 1909: “The keeping back [in] such circumstances is a fraud, and therefore the policy is void. Although the suppression should happen through mistake, without any fraudulent intention; yet still the underwriter is deceived, and the policy is void.” It thus was not actual fraud as known to the common law but a form of mistake of which the other party was not allowed to take advantage. Twelve years later in Pawson v

Watson (1778) 2 Cowp 786 at p 788, he emphasised that the avoidance of the contract was as the result of a rule of law: “But as, by the law of merchants, all dealings must be fair and honest, fraud infects and vitiates every mercantile contract. Therefore, if there is fraud in a representation, it will avoid the policy, as a fraud, but not as a part of the agreement.” …In relation to insurance Lord Mansfield was specifically addressing “concealments which avoid a policy”. This concept of avoidance most obviously applies to the making of the contract and derives, as he said in Pawson v Watson (sup)…from the application of a rule of law not from the parties’ agreement. Later developments have applied the requirement of disclosure to matters occurring after the making of the contract of insurance, namely, the affidavit of ship’s papers and the making of fraudulent claims…But, apart from some dicta, this has still been as a matter of the application of a principle of law and not through an implied contractual term. Nor was there any case prior to the Act where the principle was used otherwise than as providing a basis for resisting liability; no case was cited where the principle gave a remedy in damages, as would the tort of deceit or the breach of a contractual term. Whether there was a remedy in damages for a failure to observe good faith was finally and authoritatively considered by the Court of Appeal in Banque Keyser Ullmann SA v Skandia (UK) Insurance Co [above, [424]], affirmed by your Lordships’ House [see below, [426]]. In order to answer the question, both Steyn J at first instance ([1990] 1 QB 665 at p 699 et seq) and the Court of Appeal (p 773 et seq.) examined the basis of the requirement that good faith be observed. Having concluded on the authorities that the correct view was that the requirement arose from a principle of law,

having the character I have described, the Court of Appeal held that there was no right to damages…’

Note: For an excellent analysis of the scope of the disclosure duty, see Paul Matthews, “Uberrima Fides in Modern Insurance Law” in FD Rose (ed), New Foundations For Insurance Law, Current Legal Problems (London, Stevens & Son, 1987). See also, J Fleming, “Insurer’s breach of good faith — a new tort?” [1992] LQR 357, in which the author welcomes the decision of the New South Wales Supreme Court in Gibson v The Parkes District Hospital [1991] Austr Torts Rep 81–140, in refusing to dismiss summarily a claim for damages for an insurer’s breach of good faith in processing and paying the claimant’s workers’ compensation claim.

4.1.8 The Duration of the Duty of Ddisclosure: A Post-Contract Duty of Disclosure? It is obvious that the duty of disclosure continues up until the insurance contract is concluded. Thus, if a change of circumstance occurs which is material to the risk before the insurers accept the proposal, the insured must disclose it: see Looker v Law Union and Rock Insurance Co Ltd [1928] 1 KB 554. The duty applies to interim insurance: Mayne Nickless Ltd v Pegler [1974] 1 NSWLR 228.

In the absence of an express term to the contrary, there is no corresponding duty during the currency of the policy: Pim v Reid (1843) 6 M & G 1. In Kausar v Eagle Star Insurance Co Ltd [2000] Lloyd’s Rep 154, a clause in the policy which stated: “You must tell us of any change of circumstances after the start of the insurance which increases the risk of injury or damage…” was restrictively construed by Saville LJ so as not to impose a continuing duty of disclosure on the insured: ‘[A]ll that this Condition does is to state the position as it would exist anyway as a matter of common law, namely that without the further agreement of the insurer, there would be no cover where the circumstances had so changed that it could properly be said by the insurers that the new situation was something which, on the true construction of the policy, they had not agreed to cover. The mere fact that the chances of an insured peril operating increase during the period of the cover would not, save possibly in most extreme of circumstances, enable the insurers properly to say this, since the insurance bargain is one where, in return for the premium, they take upon themselves the risk that an insured peril will operate.’

The duty of disclosure operates more harshly in general insurance than in life insurance. General insurance policies, such as motor or household insurance, are normally short-term contracts that are typically renewed annually — at which time a new contract is entered into. The duty therefore bites at each renewal: Hearts of Oak Building Society v Law Union & Rock Insurance Co [1936] 2 All ER 619; see

Lambert v Co-operative Insurance Society [above, [416]]. While it is settled that the doctrine of utmost good faith applies to the formation of the insurance contract (including renewals), there has been considerable debate over whether the doctrine applies during the claims process and, if so, whether a fraudulent claim entitles the insurer to avoid the contract ab initio. The issue is considered in chapter 11.

4.1.9 The Insurer’s Duty of Utmost Good Faith The mutuality of the duty of utmost good faith is evident both from the judgment of Lord Mansfield in Carter v Boehm (above, [403]) and from the language of section 17 of the 1906 Act. Its content as far as the insurer is concerned was, however, framed in extremely narrow terms by the House of Lords in Banque Financière [below, [426]]. Further, in terms of the consequences following a breach of duty by the insurer there is, in practical terms, an imbalance between the parties. The insured’s breach of the duty of utmost good faith entitles the insurer to avoid the contract ab initio. On the other hand, the insurer’s breach of duty entitles the insured to rescind the contract — in effect, to a return of premiums only. Affirming the decision of the Court of Appeal, the House of Lords held that damages were not available against the insurer.

[426] Banque Financière de la Cité Sa v Westgate Insurance Co Ltd [1991] 2 AC 249 (HL) [For the approach of Slade LJ in the Court of Appeal, see Banque Keyser Ullmann SA v Skandia Insurance Co (above, [424]). This complex case involved a fraudulent scheme being perpetrated against certain banks. The banks had lent large sums of money to Ballestero, a property developer, to finance purported developments in parts of Europe. They had sought to protect their position by effecting credit insurance. Their broker twice deceived them into believing that they had insurance cover to protect them in the event of non-repayment of the loans by Ballestero when in fact they had not. The lead underwriter discovered this fraud. The banks claimed that the failure to pass this information on to them was a breach of the duty of utmost good faith and that, had they known of the fraud, they would not have made further loans. The banks could not claim under the policies when Ballestero defaulted because they contained a fraud exclusion clause. Although the issue of causation occupied much of their lordships’ reasoning, the following extract is confined to the issue of the insurers’ duty of disclosure]. Lord Jauncey: ‘What is said in this appeal is that when Dungate discovered in early June 1980 that Lee had issued fraudulent covernotes in January of that year he, as insurer, came under a duty to disclose this fact to the banks. I do not consider that the obligation of disclosure extends to such a

matter. Although there have been no reported cases involving the failure of an insurer to disclose material facts to an insured the example given by Lord Mansfield in Carter v Boehm [above, [407]] is of an insurer who insured a ship for a voyage knowing that she had already arrived…Indeed the insured would have said that the risk no longer existed. In the present case the risk to be insured was the inability, otherwise than by reason of fraud, of Ballestero and his companies to repay the loan to the banks. Lee’s dishonesty neither increased nor decreased that risk. Indeed it was irrelevant thereto. It follows that the obligation of disclosure incumbent upon Dungate, as the insurer, did not extend to telling the banks that their agent Lee was dishonest. If the obligation of disclosure incumbent upon parties to a contract of insurance could ever per se create the necessary proximity to give rise to a duty of care, a matter upon which I reserve my opinion, it is clear that the scope of any such duty would not extend to the disclosure of facts which are not material to the risk insured. It follows that the appellants’ reliance on the duty of disclosure does not assist them to establish negligence on the part of Dungate.’

Note: See T Yeo, “Of Reciprocity and Remedies: Duty of Disclosure in Insurance Contracts” [1991] LS 131; Kelly, “The insured’s rights in relation to the provision of information by the insurer” [1989] Insurance Law Journal 45; and J Birds [1990] JBL 512.

4.2 Misrepresentation Non-disclosure and misrepresentation are generally treated as one and the same thing by the judges

most probably because, as a matter of practice, insurers frequently raise both by way of defence. Yet there are significant distinctions. Non-disclosure is concerned with the insured’s duty to volunteer material facts; misrepresentation concerns the insured’s duty to accurately answer questions raised by the insurer which, as seen above in relation to waiver, are generally contained in proposal forms (if the insured’s answers are made the “basis of the contract” they are converted into warranties in which case the issue of misrepresentation does not arise (see chapter 8, below), although for consumer insurance contracts note the effect of the ABI’s Statements of Practice: General Insurance, para 1(a) (below, [433]); Long Term Insurance, para 1(b) (below, [434]). Further, for non-disclosure the law does not distinguish between innocent, negligent and fraudulent intent whereas for misrepresentation the categorisation can be crucial. Although section 20(1) of the Marine Insurance Act 1906 (above) provides that the insurer can avoid the policy in the event of a material misrepresentation, it should also be borne in mind that a fraudulent misrepresentation entitles the innocent party to bring an action for damages in the tort of deceit (see generally, J Beatson, Anson’s Law of Contract (Oxford, OUP, 2002) p 243 et seq; for the meaning of fraud at common law, see Derry v Peek (1889) 14 App Cas 337). While the general law of contract (and, of course, tort law) recognises negligent misrepresentation as distinct, it is now doubtful whether this survives in insurance law

following the decision of the Court of Appeal in Economides v Commercial Union [below, [427]]. 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 [Highlands Insurance Co v Continental Insurance Co [1987] 1 Lloyd’s Rep 109], it may assume greater significance in consumer insurance in the light of Economides (below, [427]). Further, in his Annual Report for 1990, para 2.3, the Insurance Ombudsman noted that in consumer insurance most so-called nondisclosures 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 (see further the IOB Digest on “proportionality”, above, [422]). [427] Economides v Commercial Union Assurance Co plc [1998] QB 587 (CA) [The insured effected a household contents policy with the defendants in 1998. At that time he was an 18 year old student. 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 to the best of his knowledge and (notwithstanding the Statements of Practice) 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 the insured’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. The insured, now aged 21, saw some of the jewellery as and 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 modeled on the Statements of Practice (see [433], below), stated that this was the sum insured. In 1991 the insured’s flat was burgled and property worth some £31,000 was stolen, the bulk of which being the parents’ valuables. When the insured 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].

Simon Brown LJ: ‘Misrepresentation The plaintiff has conceded throughout that at the time of the 1991 renewal he represented that to the best of his knowledge and belief (hereafter “he believed that”) the full cost of replacing all the contents of his flat as new (hereafter “the full contents value”) was £16,000. He does not, however, concede, although the judge below understood otherwise, that at the time of renewal, as opposed to the date of inception, he represented that the valuables did not account for more than one-third of that sum… What then was meant by the plaintiff’s representation that, as at January 1991, he believed that the full contents value was £16,000? The judge below considered three possible meanings: (i) that £16,000 was in fact the full value; (ii) that the plaintiff honestly believed that £16,000 was the full value and had reasonable grounds for his belief; (iii) that he honestly believed that £16,000 was the full value. The judge understood Ms Kinsler for the defendants to be contending for both (i) and (ii) and found in her favour on both, i.e. on (i), alternatively (if that went too far) on (ii). He rejected the plaintiff’s argument in favour of (iii)…In the result the issue on appeal is between (ii) and (iii): when making a representation such as this, is the assured stating merely that he honestly believes the accuracy of his valuation or, is he going further and impliedly stating too that he has reasonable grounds for that belief? That issue was, I should note, critical because whereas the judge appears to have accepted that “looking at the matter from the plaintiff’s own subjective point of view [he] was entitled to accept the figure which his father put forward” — ie he honestly believed that £16,000 was the full contents value — he concluded:

“it is clear that the plaintiff did not have reasonable grounds for the representations that he made. Knowing as he did that his parents had introduced into the flat a quantity of jewellery and silverware, 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. It is not necessary to specify what those inquiries might have involved.” In short, the judge below held that “commercial reality and common sense “required the plaintiff here as the representor to have objectively reasonable grounds for his belief; honesty alone was not enough… Mr Bartlett submits that the approach adopted by the judge below and urged afresh by Ms Kinsler on appeal is fundamentally flawed. His starting point is section 20 of the Marine Insurance Act 1906 — one of a group of sections which it is now established apply equally to non-marine as to marine insurance…The relevant subsections of section 20 are: “(3) A representation may be either a representation as to a matter of fact, or as to a matter of expectation or belief. (4) A representation as to a matter 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. (5) A representation as to a matter of expectation or belief is true if it be made in good faith.” Mr Bartlett relies in particular upon subsection (5)…He accepts, as inevitably he must, that the plaintiff had to have some basis for his statement of belief in this valuation; he could not simply make a blind guess: one cannot believe to

be true that which one has not the least idea about. But, he submits, and this is the heart of the argument, the basis of belief does not have to be an objectively reasonable one. What the plaintiff’s father told him here was a sufficient basis for his representation: he was under a duty of honesty, not a duty of care. In my judgment these submissions are well founded… I accept, of course, that…what may at first blush appear to be a representation merely of expectation or belief can on analysis be seen in certain cases to be an assertion of a specific fact. In that event the case is governed by subsections (3) and (4) rather than (5) of section 20 and I accept too, as already indicated, that there must be some basis for a representation of belief before it can be said to be made in good faith…In my judgment the requirement is rather, as section 20(5) states, solely one of honesty. There are practical and policy considerations too. What, would amount to reasonable grounds for belief in this sort of situation? What must a householder seeking contents insurance do? Must he obtain professional valuations of all his goods and chattels? The judge below held that: “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. It is not necessary to specify what those inquiries might have involved.” The problem with not specifying them, however, is that householders are left entirely uncertain of the obligations put upon them and at risk of having insurers seek to avoid liability under the policies. There would be endless scope for dispute. In my judgment, if insurers wish to place upon their assured an obligation to carry out specific inquiries or otherwise take steps to provide objective justification for their valuations, they must spell out these requirements in the proposal form.

I would hold, therefore, that the sole obligation upon the plaintiff when he represented to the defendants on renewal that he believed the full contents value to be £16,000 was that of honesty. That obligation the judge apparently found him to have satisfied. Certainly, given that the plaintiff was at the time aged 21, given that the figure for the increase in cover was put forward by his father, and given that father was a retired senior police officer, inevitably better able than the plaintiff himself to put a valuation on the additional contents, there would seem to me every reason to accept the plaintiff’s honesty…

Non-disclosure …During argument before us, however, it became apparent that what is really being said here is that the plaintiff was bound to disclose: (i) that the full cost of replacing the contents was substantially more than £16,000, and (ii) that the valuables were worth very considerably more than £5,333 or, indeed, very substantially more than one-third of the actual total value of the contents… It seems to me that the governing principle is that to be found in section 18(1) of the Act of 1906 [above]… It is clearly established that an assured such as this plaintiff, effecting insurance cover as a private individual and not “in the ordinary course of business,” must disclose only material facts known to him; he is not to have ascribed to him any form of deemed or constructive knowledge… And that, indeed, as I understand it, had earlier been the position at common law. In Blackburn Low & Co v Vigors (1887) 12 App.Cas. 531, 543 Lord Macnaghten said: “it would, in my opinion, be a dangerous extension of the doctrine of constructive notice to hold that persons who are themselves absolutely innocent of any concealment or misrepresentation, and who have not wilfully shut their eyes or closed their ears to any means of information, are to be

affected with the knowledge of matters which other persons may be morally though not legally bound to communicate to them.” and as was said by Fletcher Moulton LJ in Joel v Law Union and Crown Insurance Co [1908] 2 KB 863, 884: “The duty is a duty to disclose, and you cannot disclose what you do not know. The obligation to disclose, therefore, necessarily depends on the knowledge you possess.” In short, I have not the least doubt that the sole obligation on an assured in the position of this plaintiff is one of honesty. Honesty, of course, requires, as Lord Macnaghten said in the Blackburn Low case,12 App Cas 531, 543 that the assured does not wilfully shut his eyes to the truth. But that, sometimes called Nelsonian blindness — the deliberate putting of the telescope to the blind eye — is equivalent to knowledge, a very different thing from imputing knowledge of a fact to someone who is in truth ignorant of it. The test, accordingly, for non-disclosure was in my judgment precisely the same as that for misrepresentation, that of honesty. and by the same token that the plaintiff was under no obligation to make further inquiries to establish reasonable grounds for his belief in the accuracy of his valuations, so too he was not required to inquire further into the facts so as to discharge his obligation to disclose all material facts known to him. Indeed the plaintiff’s case on nondisclosure seems to me a fortiori to his case on misrepresentation. The Association of British Insurers’ “Statement of General Insurance Practice” (1986) [see below, [433]] states with regard to proposal forms: “(d) Those matters which insurers have found generally to be material will be the subject of clear questions in proposal forms.” Where, as here, material facts duly are dealt with by specific questions in the proposal form and no sustainable case of misrepresentation arises, it would be remarkable

indeed if the policy could then be avoided on grounds of non-disclosure. What, then, of the judge’s conclusions of fact on this part of the case? I have, I confess, great difficulty in understanding how the judge concluded that “there was here a wilful shutting of the plaintiff’s eyes to the reality of the situation.” That, as stated, is tantamount to a finding of dishonesty and yet that seems to me not merely unjustifiable on the facts but positively inconsistent with what I understand the judge to have found on the issue of misrepresentation… By way of footnote I wish to add this. The issue of nondisclosure has throughout been dealt with, as stated, upon the plaintiff’s concession as to materiality. Certain aspects of this concession have, however, made me uneasy. In the first place I note these paragraphs in MacGillivray and Parkington on Insurance Law, 8th edn. (1988), p 777: “1730. Under-insurance. Under a non-marine policy of insurance the insured can recover the whole amount of his loss up to the limit of the sum insured. He may, therefore, obtain insurance at a small premium by understating the value of the subject matter insured, but nevertheless make recovery in a sum up to the amount insured; where there is a partial loss he may even be able to recover the full amount of his loss and suffer no penalty for being underinsured. “1731. It has therefore become the almost invariable practice for insurers to declare that the policy is ‘subject to average’ or ‘subject to the under-mentioned condition of average’ which means that, if the sum insured does not represent the value of the property insured at the time of the loss or damage, the insured is to be his own insurer for the requisite proportion of the insurance and must therefore bear a part of the loss accordingly. In Careers Ltd v Cunard Steamship Co [1918] 1 KB 118 where the plaintiff company

warehoused goods with the defendant company at a fixed rental to include insurance against loss or damage by fire, Bailhache J. held that the so-called pro-rata condition of average was so common in fire insurances on merchandise that it must be implied as a term of the warehouse agreement. The average clause now occurs in almost all policies, except those relating to private dwelling-houses and household goods, and to buildings (and their contents) used wholly or mainly for religious worship.” Ordinarily, therefore, it appears, under-insurance, so far from being regarded as material nondisclosure justifying the avoidance of the policy, results instead in averaging, or indeed in full recovery without penalty. Why then should the position be so very different in the present case, not least given that the policy itself expressly envisages at least some degree of underinsurance: “If at the time of any loss or damage the cost of replacing all the contents as new is greater than the capital sum insured then any payment under the home contents section will be made after a deduction for any wear or depreciation.” And that leads me to the second point. Just how substantial must be the extent of underinsurance (or the excess beyond one-third in the proportion of valuables to the total) before it is said, assuming always that the assured had knowledge of these facts, that the policy can be avoided on grounds of non-disclosure? None of these questions were addressed before us, nor indeed, having regard to my conclusions on the central issues, did they need to be. I raise them, however, because in other circumstances it seems to me that they are likely to have considerable importance and accordingly should not be lost sight of. For the reasons given earlier, however, I would allow this appeal and enter judgment for the plaintiff against the defendants in the sum of £7,815.38 together with interest.’

Note: For comment, see See H Bennett [1998] MLR 886; and N Hird [1998] JBL 279

4.2.1

Non-Disclosure and Misrepresentation in Composite Insurance

As will be seen in chapter 6 in relation to construction insurance, it is not uncommon for one insurance policy to cover the separate interests of a head contractor and all the sub-contractors involved in a building project. Similarly, one policy will often cover the separate interests of a mortgagor and mortgagee in the same property. The issue that arises in such coinsurance situations is whether the non-disclosure or misrepresentation on the part of one co-insured will entitle the insurer to avoid the contract as against all parties (ie including the innocent co-insureds) or merely against the guilty co-insured. The solution depends upon whether the policy is construed as separate contracts or as a single contract. Rix J in the Arab Bank case (below, [428]) reasoned that composite policies should be viewed prima facie as ‘a bundle of separate contracts’ between the insurers and the co-insureds so that, therefore, dishonesty by one co-insured did not permit the insurers to avoid the policy against all the other parties. This approach has been criticised as going too far [see J Birds, [1999] JBL 151], although it has been tacitly endorsed by the Court of Appeal in FNCB Ltd v Barnet Devanney (Harrow) Ltd [1999] Lloyd’s Rep IR 459.

[428] Arab Bank plc v Zurich Insurance Co [1999] 1 Lloyd’s Rep 262 [Browne, (B), was the managing director of John D Wood Commercial Ltd (JDW), an incorporated firm of professional estate agents and valuers. He was at all material times a substantial shareholder in the company. B prepared valuations for banks which were fraudulently high in that the valuation figures were deliberately or recklessly provided and did not represent the open market value of the properties: the figures were in each case grossly in excess of the true open market value and/or recent sale price. On occasions B was assisted by another director and a (relatively minor) shareholder, Pitts (P). The company received the valuation fees. The other directors of JDW were innocent and free of any fraudulent conduct or intent to deceive. The claimants, Arab Bank and Banque Bruxelles Lambert SA, obtained judgments against JDW in negligence but when the company went into liquidation they sought to enforce those judgments directly against the company’s underwriters, Zurich, under the Third Parties (Rights against Insurers) Act, 1930. Zurich argued that B’s fraud relieved them from liability. The indemnity insurance in question had been effected in August 1990. B had completed the proposal form. Question 14(a) of the proposal asked: “Is any Partner, Director, Principal, Consultant or employee, AFTER ENQUIRY, aware of any circumstances/incidents which might:

(i) give rise to a claim against the Proposer or his predecessors in business or any of the present or former Partners, Directors, Principals?… (iii) otherwise affect the consideration of this proposal for Professional Indemnity insurance?”

B answered yes to question (i), but no to question (iii), and in explanation of his answer to question (i) merely referred to a minor issue concerning a possible loss of rent and a possible claim under £10,000. This was irrelevant to the present disputes. The proposal concluded as follows: “I/We warrant that the above statements made by me/us or on my/our behalf are to the best of my/our knowledge true and complete and I/we agree that this proposal shall be the basis of the contract between me/us and the Insurer. I/We further warrant that no higher limits(s) Insurance have been, or will be, effected by me/Us unless agreed.”

The insurers contended that B had failed to disclose material facts and that his answers constituted a breach of warranty. It was material that the proviso in the ‘basis of the contract clause’ that the answers were true to the best of B’s knowledge meant that they were warranties of opinion not absolute guarantees as to their accuracy. Part I of the policy defined ‘the insured’ as the ‘firm,’ including its directors and employees with the proviso that ‘such definition of the term ‘Insured’ shall NOT be construed to mean that the Company shall indemnify any person knowingly committing, making or condoning any dishonest, fraudulent or

malicious act or omission.’ Other conditions in the policy included, among others, a fraudulent claim clause (condition 1), a waiver of the insurers rights in the event of innocent non-disclosure (condition 2), a waiver of subrogation (condition 5) and a term requiring notification of any circumstance arising during the currency of the policy which might give rise to a claim (condition 6). The primary issue was whether JDW, the principal insured, could recover under its professional indemnity policy on the basis that the dishonest mind and knowledge of its managing director could not be attributed to it]. Rix J: ‘The construction of the policy …In my judgment, there are three interlinked questions which have to be resolved. One is a question of construction, one is a question of the conceptual analysis of the nature of a composite policy such as the one before me, and the third is a question of attribution. Because the three are interlinked, it is not easy to know which is the one to start with: but probably the order in which I have mentioned them will do as well as any other. The question of construction, the essential question of construction, is whether the policy will respond in the case of the dishonesty of any of the insureds in favour of another insured who is not complicit in that dishonesty. The answer to that question is perhaps common ground, but I will in any event state that in my judgment the policy not only does respond in such a case, but has been specifically designed so to do. Normally, a policy does not deal specifically with the dishonesty of an assured, save possibly to include an

express term, which would otherwise be implied, to say that fraud in the making of a claim would render the policy forfeit…It is likewise implicit in the nature of insurance that a loss caused by the deliberate dishonesty of an assured is not covered: this is reflected in section 55(2)(a) of the Marine Insurance Act 1906 which provides that the insurer is not liable for any loss attributable to the wilful misconduct of the assured. Even so, it is implicit in the nature of a composite policy that one assured is not prejudiced by the dishonesty of another, provided that the other is not a joint assured: Samuel & Co Ltd v Dumas [1924] AC 431… In the present case, however, the policy goes much further than is normally done (at any rate outside the context of professional indemnity insurance) in emphasising that the dishonesty of one insured will not be held against another insured who is not complicit. This is seen in a number of places within the policy. First, in the proviso to the insuring clause of the professional indemnity section: when read together with the cover “in respect of any Civil Liability whatsoever”, which prima facie is wide enough to embrace liability for dishonesty, the proviso by excluding cover for “any person knowingly committing, making or condoning any dishonest, fraudulent or malicious act or omission” impliedly confirms that there is cover for a liability for dishonesty in favour of an insured who is not complicit in that dishonesty within the terms of the proviso. There is, secondly, a similar provision in the insuring clause of the infidelity cover under sub-section B of section 2. Thirdly, the subrogation provisions in general condition 5 make it plain that Zurich will pay claims even where an insured partner, director or employee has been guilty of a “dishonest, fraudulent, criminal or malicious act or omission” — in the absence of payment there could of course be no question of subrogation — but can only recover under rights of subrogation against guilty insureds. All this is, as I believe, common ground: and it is common ground that in the case

of an archetypal instance of this policy being taken out by the partners of a firm, none of the innocent partners would be affected by the dishonesty of the guilty. Therefore, this policy is not merely a composite policy with the normal attributes of such, but has been specifically designed to provide cover to innocent insureds despite the guilt of their close associates and agents. A partner is, after all, at root an agent for the rest of his partners…As a matter of construction, therefore, I do not see that there is any difference in principle for these purposes between the case of a partnership and the case of a company. Whether rules of attribution will require a different approach will have to be considered below: but that consideration will have to take place in the context of these preliminary thoughts about the policy’s construction… In the context of construction, there are however two further provisions of the policy which I have not so far mentioned where it may be said that questions perhaps remain, owing to the failure of the clauses’ language to be sufficiently specific. The first is the fraud forfeiture provision at general condition 1, and the other is the innocent nondisclosure provision at general condition 2. In neither case is it made clear by the terms of those clauses whether the clause operates for and against each insured separately or whether dishonesty on the part of any insured whether in making a claim or in non-disclosure at the time of making the contract renders the policy liable to forfeiture or avoidance once and for all. These questions of construction are closely bound up with the analysis of composite policies and rules of attribution, but I shall approach them initially as a matter of pure construction. General condition 1 is perhaps the easier of the two. I shall repeat it for convenience: “If any claim under this Certificate of Insurance shall be in any respect fraudulent or if any fraudulent means or devices

are used by the Insured to obtain any benefit under this Certificate of Insurance all benefit thereunder shall be forfeited.” It seems to me that the clue is to be found in the words “or if any fraudulent means or devices are used by the Insured”. If one insured is innocent and another guilty, it seems to me that those words can only apply to the guilty insured. It is only the guilty insured who can be “the insured” for such purposes, for where an insured is innocent, it cannot be said of him that “fraudulent means or devices are used by the Insured”. If therefore the underwriters had intended to forfeit the policy against all insureds, the innocent as well as the guilty, then they should have drafted the clause at least in terms of “if any fraudulent means or devices are used by any Insured”. It is I suppose a possible, albeit unlikely and exceptionally draconian remedy, for which underwriters might stipulate, that the whole policy should be forfeit for any fraud by any insured: but as the authorities on composite policies cited above demonstrate, the Court will not in the ordinary case construe a composite policy as being rendered potentially valueless let alone completely destroyed by the fraud of only one insured. If, therefore, underwriters wish to stipulate for such a draconian remedy, they should make their intent perfectly clear… As for general condition 2, I repeat that too for my reader’s convenience: “The Company will not exercise its right to avoid the Certificate of Insurance where it is alleged that there has been non-disclosure or mis-representation of facts or untrue statements in the proposal and in conjunction with any subsequent proposal form(s) provided always that the insured shall establish to the Company’s satisfaction that such alleged non-disclosure, mis-representation or untrue

statement, was innocent and free of any fraudulent conduct or intent to deceive.” The issue here is whether this clause, in particular the benefit granted to the insureds under its proviso, operates in favour of each insured separately, or whether, as Mr Tomlinson submitted, it is only concerned with the quality of the non-disclosure etc, so that lack of innocence on the part of any insured will entitle avoidance. In the former case, it is as though the clause ended with the words “on his part”. It seems to me that Mr Tomlinson’s construction would be all very well in a different context, but that in the context of this policy the term “the insured” should again be regarded as applying to each of the insureds separately. Therefore any insured who is personally innocent of an intent to deceive should be entitled to resist avoidance. Mr Tomlinson argued that if there was only one composite contract, then the guilt of any insured would entitle avoidance, since a contract was either avoided or it was not. In this connection he relied upon a passage in MacGillivray, 9th edn, 1997 at paras. 17–28. I shall have to return to this argument in discussing below the analysis of the concept of composite contracts. For the present, however, I would remark that the same argument if applied to general condition 1 would have led to the forfeiture of the whole contract for the fraud of only one insured… In this context too there is an authority which is relevant, which the plaintiffs have strongly relied upon, but Mr Tomlinson has said should be distinguished. It is a case in the British Columbia Court of Appeal, Fisher v Guardian Insurance Co of Canada [1995] 123 DLR (4th) 336. The policy there was a lawyers’ errors and omissions insurance procured on the false application of a dishonest lawyer, Cowan, in favour of himself and his former entirely innocent partners, Shaver and Fisher. A previous judgment had held the three partners liable to a third party, and the question

was whether Shaver and Fisher were entitled to be indemnified under the Guardian policy. Cowan had fraudulently stated in his application that he had no reason to anticipate claims against him, when he had every reason, so much so that he ended up in prison. Guardian argued that Cowan’s false declaration should be imputed to Shaver and Fisher. It also relied on an exclusion of any claim arising out of any act committed by “the Insured” with actual dishonest intent. Shaver and Fisher, on the other hand, relied on a “waiver of exclusions and breach of conditions” clause as follows: “Whenever coverage under any provision of this Policy would be excluded, suspended or lost: (i) because of any dishonest, fraudulent or criminal act or omission of any Insured…the Insurer agrees that such insurance as would otherwise be afforded under this policy shall continue in effect, cover and be paid with respect to each and every Insured who did not commit or personally participate in or acquiesce in such activity…” I shall return to the Court of Appeal’s judgment in considering the question of attribution below: for the present I am primarily concerned with questions of construction. The Court of Appeal founded itself in turn on a judgment of the Supreme Court of Canada in Panzera v Simcoe & Erie Insurance Co [1990] 74 DLR (4th) 197, where a mortgagee claimed similarly not to be affected by the misrepresentation of the mortgagor in procuring the insurance, and where the policy included a “standard mortgagee clause” providing that: “This insurance…AS TO THE INTEREST OF THE MORTGAGEE ONLY THEREIN — is and shall be in force notwithstanding

any act, neglect, omission, or misrepresentation attributable to the mortgagor…” The Supreme Court held that this clause protected the mortgagee against the mortgagor’s misrepresentation even in the formation of the contract: in effect there was a separate contract of insurance between mortgagee and insurer. Mr Justice La Forest, who gave the majority judgment, said (at p 200): “It should also be noted that the American jurisprudence dealing with the narrow issue raised by this appeal is all but unanimous in concluding that by virtue of the two-contract theory, the insurance of the mortgagee cannot be invalidated by any act or neglect of the mortgagor, be it at the inception of the policy, or subsequent to its formation… Thus the overwhelming majority of the decisions are in essential agreement with the interpretation of the clause that would seem to have first emerged in the decision of the New York Court of Appeal in Hastings v Westchester Fire Ins Co 73 NY 141 (1878). There Rapallo J stated the following, at p 153: To hold otherwise would, I think, defeat the purpose intended, and deprive the mortgagees of the protection upon which they had a right to rely. Although the clause might be construed so as to exempt the mortgagees from the consequences only of acts of the owners done after the making of the agreement, I do not think, in view of its apparent purpose, that any such distinction was intended.”

On the question of the interplay between the concept of attribution and the construction of the standard mortgagee clause, Mr Justice La Forest said this (at pp 214–215): “I noted earlier that by the terms of the standard mortgage clause the mortgagor, when insuring its own interest in the property, assumes a mandate to take out a separate contract of insurance to insure the mortgagee’s interest.

This raises the question whether it could be argued that because the mortgagor is acting as the mandatory of the mortgagee when it insures the mortgagee’s interest, it therefore follows that any false representations made by the mortgagor in effecting its mandate should be held to be those of the mortgagee. On this logic, the invalidity of the mortgagor’s contract would entrain the invalidity of the mortgagee’s contract as well. I do not see how one can reasonably infer that the law of mandate operates so as to have this effect in the context of the standard mortgage clause…As put by Miller J in Hastings, supra, at p 150: The mortgage clause was agreed for this very purpose, and created an independent and new contract, which removes the mortgagees beyond the control of the effect of any act or neglect of the owner of the property, and renders such mortgagees parties who have a distinct interest from the owner, embraced in another and a different contract.”

Finch, JA, who gave the judgment of the Court in Fisher, followed the logic of the Supreme Court in giving effect to the waiver of exclusions clause as superseding any doctrine of attribution, and added (at p 350): “Guardian had the means to protect itself either in the way it chose to issue the coverage, or by the choice of language in the policy. It seems more realistic, in these circumstances, to resolve disputes over the rights of multiple insureds under the contract on the basis of the language the insurer chose to employ in the policy, than to impute wrongdoing to an innocent insured on the basis of a notional and wholly artificial “agency”.

Such an approach is also more in accord with the realities of modern law practice. Modern firms frequently comprise dozens, sometimes hundreds, of lawyers. Some are partners, some are employees. The members of the firm in both categories change from time to time, as partners and associates retire, new partners are created, and new associates are employed. The only practical means of insuring against liability, in these circumstances, is for one application to be made by a responsible member of the firm, acting on behalf of all the others. If insurers could deny coverage to the hundreds of Canadian lawyers insured in this way, because of the misrepresentation of the individual who filled out their application on their behalf, the consequences to the public and to the profession would be enormous, quite unanticipated, and entirely inconsistent with the practical realities faced by the legal profession and the insurance industry.” Mr Tomlinson submitted that Fisher was of no assistance because it concerned partnership and because, like Panzera, it was based on the construction of a special clause, which in both cases went much further than general condition 2. I would agree that in certain respects the clauses in both cases are more explicit than general condition 2 taken by itself. But they are not more explicit than the policy terms which I have been considering as a whole; and with respect to the formation of the contract of insurance, which was the focus of the issue in both cases, those clauses were very much less explicit. The Panzera clause referred to “any misrepresentation” without stating expressly that that referred to misrepresentation before as well as after the making of the contract; and the Fisher clause did not refer to misrepresentation at all. In the present case on the other hand, general condition 2 is clearly dealing with dishonesty and innocence in the making of the contract of insurance, and the question is simply whether that applies separately

to each of the insureds. The lesson of the Canadian case is that such clauses should be regarded as reflecting separate contracts of insurance for the various insureds, and that where there are separate contracts, each insured is entitled to be judged in matters germane to the making of the contract separately. That is the language of composite policies, and it is to the analysis of that concept that I now turn.

Composite policies In this second context, Mr Tomlinson points out, correctly, that Samuel v Dumas was concerned with fraud in the performance of the insurance contract, and not with fraud or non-disclosure in the formation of it. On the basis of a passage in MacGillivray at paras 17–28, he submits that it is only where a composite policy is in truth a bundle of entirely separate contracts that the right to avoid for one assured’s non-disclosure or misrepresentation in the formation of the contract does not automatically bring the whole policy down with it. The present policy, he submits, with its single premium for each section, is not such a bundle of contracts. The practical difficulty of that submission, however, is that in my judgment it is at odds with the Court of Appeal’s holding in New Hampshire Insurance Co v MGN Ltd [1997] LRLR 24. That case concerned fidelity insurance policies under which member companies of the Maxwell group were insured. Various companies made claims under them in respect of losses alleged to have been suffered as a result of dishonest acts on the part of Mr Robert Maxwell. Among the issues litigated was so-called issue G, which raised the question whether a non-disclosure, misrepresentation or breach of the duty of utmost good faith by one assured of itself placed all assureds in the same boat and entitled the underwriters to avoid against all. At first instance Potter J having held that the policies were composite by nature (issue F), went on to hold (at p 42) that the answer to issue

G was No. He accepted albeit only “in principle” the submission that – “…where an independent interest is separately insured, there can be no question of avoiding the policy for nondisclosure quoad that interest unless the person so insured was privy to the non-disclosure.” He added: “Nor do I consider that there is any wording apposite to alter or detract from the application of that principle under the policies before me.” However, Potter J sounded a warning as to whether his answer as a matter of principle would solve the factual questions which arose in the case, saying (at p 43): “However, in the context of the Maxwell group, the interrelationship of various of the companies and the overlapping employment and functions of a number of their servants and officers, are likely to have created situations whereby an officer of company A, as well as exercising functions in company B, would also have had knowledge of the affairs of company C and/or the actions or intentions of its officers of such a kind that he would have been under parallel duties of disclosure and/or obligations of good faith in respect of all three.” The Court of Appeal, whose judgment was given by Staughton LJ, agreed…they held that the various assureds were “the owners of separate interests which were to be covered by insurance separately”. As for issue G, they said: Technically one ought to enquire whether for each layer in each year there was one contract, or as many contracts as there were companies insured. and if the former, can a

contract be avoided for non-disclosure as against one or some of the insured, but not against the others? We feel that we are relieved from the need to answer those questions by the authority of the House of Lords, in the passage already quoted from P Samuel & Co. Ltd. v Dumas. That, it is true, was not a case of non-disclosure but of wilful misconduct by one of the two persons insured. But in our opinion the principle that the innocent party can still recover if it is a separate insurance must equally apply. …It seems to me that the Court of Appeal were saying that in the typical case of a composite policy where there are several assureds with separate interests, the single policy is indeed a bundle of separate contracts. That is the prima facie position under a composite policy, without any need for a meticulous examination, for instance, to see whether separate premiums have been agreed for the various interests. Indeed, one can well understand that on a practical level it would be unrealistic to expect the separate interests to be divided out and severally assessed… Although Samuel v Dumas was a case of wilful misconduct and not non-disclosure (as Staughton LJ himself remarked), the scuttling of the vessel with the connivance of her owners coupled with the owners’ fraudulent claim (which failed at first instance and was never renewed by way of appeal) was of course a fraud on their insurers which was treated as entitling the latter to avoid the policy. That was the argument pressed on the Court by the insurers…In rejecting that argument on the ground that the mortgagee had a separate interest, Viscount Cave was saying in effect that conduct which would entitle the insurers to avoid against one assured will not avail against another assured with a separate interest, if innocent. That reasoning is directly applicable to a case of non-disclosure or misrepresentation in the formation of the contract. A right to

avoid (or forfeit) does not destroy a composite contract once and for all. The question remains, of course, as Potter J remarked, whether on the facts of any case, even under a composite policy, and, I would add, subject to special language such as found in this case, the breach of good faith in the formation of a contract by one assured is also to be attributed to another assured under the same policy, because the knowledge of one is to be treated as the knowledge of the other. It does not, however, happen automatically… Is there any reason to suppose against this background of authority that the policy in this case is not to be treated likewise as a bundle of separate contracts under which [B] (and [P]) and the company JDW are separately insured for their own separate interests? In my opinion, No. The professional indemnity insuring clause itself makes clear that there are several insureds. Obviously, the “Firm” which is the primary insured may have separate interests from those of any partner, director or employee or former partner, director or employee, and each of these natural persons may have interests different from one another… [T]he policy in this case contains other indications that the various insureds are to be treated as parties to separate contracts, not affected by the dishonesty of another insured if they are themselves innocent. Even in the absence of such clauses, MGN indicates that the rule in principle in the case of a composite policy is that the breach of the duty of good faith by one assured is not automatically to be laid against another innocent assured. The presence of such clauses as the insuring clause proviso and general condition 5 (and in my judgment general conditions 1 and 2 as well) is an alternative route to and a confirmation of the finding in this case of a bundle of separate contracts. The Canadian cases, which proceed on the basis of the separate contract rule where the construction of the policy allows it, are in this connection consistent and supportive…

Rules of attribution I turn, thirdly, to the subject of rules of attribution. The question is whether the dishonesty of [B] (and [P]) and their dishonest knowledge are to be attributed to JDW itself. For if so, then it does not avail JDW to be a separate insured, separately insured. [B’s] dishonesty and dishonest knowledge become JDW’s own… …I have been referred by all parties to what Lord Hoffmann said in Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500 about rules of attribution in the context of companies. They can vary, depending on the context, from rules as broad as the general principles of agency or vicarious liability, to those as focused as the requirements of a resolution of the board or of an unanimous agreement of shareholders, the latter being what Lord Hoffmann called a company’s “primary rules of attribution”. At p 507E–F he said: “But there will be many cases in which neither of these solutions is satisfactory; in which the court considers that the law was intended to apply to companies and that, although it excludes ordinary vicarious liability, insistence on the primary rules of attribution would in practice defeat that intention. In such a case, the court must fashion a special rule of attribution for the particular substantive rule. This is always a matter of interpretation: given that it was intended to apply to a company, how was it intended to apply? Whose act (or knowledge, or state of mind) was for this purpose intended to count as the act etc. of the company? One finds the answer to this question by applying the usual canons of interpretation, taking into account the language of the rule (if it is a statute) and its content and policy.” …I think that Mr Boswood and Mr Goldsmith are right in their reliance on the Hampshire Land exception. In In re

Hampshire Land Co [1896] 2 Ch 743 money was lent by a building society to the company. The secretary of both the building society and the company was the same individual, Mr Wills. He knew that there was an irregularity in the consent given in general meeting by the company’s shareholders, in that, although they authorised the borrowing in question, they had not been told in the meeting’s notice, as required, that the borrowing was in excess of the directors’ borrowing powers without shareholders’ consent. The question was whether the building society could prove in the company’s winding-up, or could not do so because Mr Wills’ knowledge of that irregularity was to be attributed, through him, to it. Vaughan Williams J held that his knowledge could not be attributed. He said that the case was no different whether it was regarded as one of breach of duty or fraud (at pp 749–50): “common sense at once leads one to the conclusion that it would be impossible to infer that the duty, either of giving or receiving notice, will be received where the common agent is himself guilty of fraud. It seems to me that if you assume here that Mr Wills was guilty of irregularity — a breach of duty in respect of these transactions — the same inference is to be drawn as if he had been guilty of fraud. I do not know, I am sure, whether he was guilty of actual fraud; but whether his conduct amounted to fraud or to breach of duty, I decline to hold that his knowledge of his own fraud or of his own breach of duty is, under the circumstances, the knowledge of the company [sc. the society].” The rationale of this exception, or as I would prefer to call it, this rule of attribution, was there based on “common sense” and was not confined to fraud, but extended generally to any breach of duty which prevented the inference that the agent would communicate his knowledge to the principal…

[I]n the insurance context, as outside it, a director’s knowledge is not to be attributed to his company, whether as the knowledge of the company itself, or as knowledge which in the ordinary course of business that company is to be inferred or deemed to know, to the extent that his knowledge is of his own acting in fraud of his company; and that for these purposes it does not matter whether the director is to be regarded as an agent to insure or not… In my judgment, [B’s] fault comes within the concept of an agent’s fraud on his principal, but, even if it does not, his fault is such a breach of duty to JDW as in justice and common sense must entail that it is impossible to infer that his knowledge of his own dishonesty was transferred to JDW… It follows that the Hampshire Land doctrine would in any event prevent [B’s] or [P’s] knowledge being attributed to JDW.

The warranty in the proposal There remains the fact that the proposal, completed by [B], contained a warranty that the statements made in the proposal “are to the best of my/our knowledge true and complete” and the agreement that the proposal “shall be the basis of the contract between me/us and the Insurer”. It follows that the truth of those statements “to the best of my/our knowledge” became a condition of the liability of Zurich: Dawsons Ltd v Bonnin [1922] 2 AC 413. Unlike the position in Dawsons Ltd v Bonnin, however, the warranty was not simply as to the statements’ truth, but was qualified by the expression “to the best of my/our knowledge”. [B] of course knew that he had misstated his answers to the questions whether any director was aware of any circumstances which might give rise to a claim or otherwise affect the consideration of the proposal. On the assumed facts, however, none of the other directors, apart from [P],

was aware of the fraudulent valuations or that [B’s] warranty on their behalf was untrue or incomplete… In these circumstances and in the light of my construction of general condition 2, and of the policy as a whole as a bundle of separate contracts, it seems to me to follow that it has to be asked whether the warranty was broken by JDW as well as by [B]. It will only have been broken by JDW if [B’s] knowledge is attributed to JDW: but for the reasons I have already given, I do not believe that his knowledge can be so attributed…’

4.3 Criticisms, Calls for Reform and the ABI Statements of Practice Notwithstanding various calls for reform over the last 50 years or so, insurers have successfully fought a rear guard action to prevent any legislative intervention that might dilute the disclosure duty. In 1957 the Law Reform Committee published its Fifth Report, Conditions and Exceptions on Insurance Policies, Cmnd 62, which considered the harshness of the duty (referred to by the Court of Appeal in Lambert v CIS, above [416]). Its proposals for reform went unheeded ‘probably because the government of the day accepted the insurance industry’s word that, in practice, insurers only relied on their strict legal rights when they suspected, but could not prove, fraud’ (Report on Insurance Law Reform (London, NCC, 1997) at 29). The next major call for reform came in 1980 when the Law Commission published its report, No 104, Insurance Law — Non-Disclosure and Breach of Warranty, Cmnd 8064. The Law

Commission concluded that the disclosure duty was ‘far too stringent’. Eventually the DTI belatedly issued a draft Insurance Bill for consultation. Nothing came of this. In 1986 the government announced that it was satisfied that the Statements of Practice issued by the Association of British Insurers in 1977 (and revised in 1986, see below, [433] and [434]), in return for achieving exemption for the industry from the Unfair Contract Terms Act 1977, struck the appropriate balance for the consumer-insured. More recently, a thorough review of the disclosure duty, among other areas of insurance law, was undertaken by the National Consumer Council in 1997. Its report, Insurance Law Reform — The consumer case for a review of insurance law (written by Professor Birds), took the Australian Insurance Contracts Act 1984 (below, [432]) as its template in framing its proposals for reform of UK insurance law. Finally, in January 2001 the British Insurance Law Association established a sub-committee to examine contentious areas of insurance law and to make recommendations to the Law Commission ‘as to the desirability of drafting a new Insurance Contracts Act….’ Its report, Insurance Contract Law Reform, was published in September 2002 (see below, [438]). [429] R Hasson, “The doctrine of uberrima fides in insurance law — a critical evaluation” [1969] MLR 615 ‘…the so called uberrima fides principle — has been subjected to virtually no critical assessment by either

English courts or commentators. In this paper, an attempt will be made to suggest that the current English principle is thoroughly unsatisfactory in that it does not reflect the “reasonable expectations” of insurer and insured and in that it is a rule that works against “fairness” in the insurance contract. An attempt will also be made to show that the classical doctrine on this subject as stated in the leading case of Carter v Boehm (1766) 3 Burr 1905, has been misunderstood and misapplied by English courts. By way of sharp contrast American courts in the nineteenth century correctly understood and interpreted the case. In Rozanes v Bowen [1928] Ll L Rep 98 Scrutton LJ said that, “It has been for centuries in England the law in connection with insurance of all sorts…[that] it is the duty of the assured…to make a full disclosure to the underwriters without being asked of all the material circumstances…” Since the above passage reflects a very widely held assumption among both English judges and commentators, it would be well to examine its accuracy. It is submitted that the statement quoted above reflects only very recent judicial doctrine and not a rule of great antiquity… All this leads us to Carter v Boehm…A reasonably careful reading of the opinion, however, makes it clear that Lord Mansfield placed the responsibility for obtaining the relevant material information on the insurer. After all, it was the insured, and not…the insurer, who was the successful party in the litigation. The most important concealment alleged by the insurer was with regard to the “condition of the place”. On this point Lord Mansfield said: “The underwriter knew the insurance was for the governor. He knew the governor must be acquainted with the state of the place. He knew the governor could not disclose it, consistently with his duty. He knew the governor, by

insuring, apprehended, at least, the possibility of an attack. With this knowledge, without asking a question, he underwrote. By so doing, he took the knowledge of the state of the place upon himself. It was a matter, as to which he might be informed in various ways: it was not a matter, within the private knowledge of the governor only.” This passage would seem to indicate beyond any doubt that Lord Mansfield conceived of the insured’s duty as being a very narrow one… Twentieth-Century Fundamentalism The conflict between the “broad” and the “narrow” duty of disclosure may fairly be said to have been finally resolved in favour of the former theory by the decision of the Court of Appeal in Joel v Law Union and Crown Insurance [1908] 2 KB 863. Since the date of that decision, the only question has been as to the breadth of the duty to disclose. In Joel itself, the Court of Appeal drew a distinction: the assured was under no duty to disclose facts he did not know of, since, as Fletcher Moulton LJ put it, “you cannot disclose what you do not know”. On the other hand, if the assured knew of a fact, his duty to disclose was not affected by the fact that he (the assured) thought the fact was not a material one. In Australia and New Zealand Bank Ltd v Colonial and Eagle Wharves Ltd [1960] 2 Lloyd’s Rep 241, McNair J remarked obiter that the “trend of opinion” supported the view that the assured was under a duty to disclose not only known facts but also such facts, which in the ordinary course of business he the assured might reasonably be expected to discover.”… It is now proposed to examine some of the case law with regard to the duty to disclose four allegedly material facts. These particular facts have been chosen both for their importance in practice and also because they demonstrate

very clearly the unfortunate results that are liable to occur when it is sought to apply an unsatisfactory rule. (1) The claims history of the insured — including notice of rejection The law in this area shows a remarkable cleavage between marine insurance situations (where the duty to disclose is extremely narrow) and the situation prevailing in other fields of insurance law where an unfairly broad duty of disclosure applies. Thus, although it would be fatal to the assured’s claim in a marine insurance situation to represent untruthfully that previous underwriters have taken the proposed risk at the same or at a lower premium, yet the insured is not bound to disclose the fact that the other underwriters have previously declined to accept the same risk. Similarly, the insured is under no duty to report any apprehensions that may have been expressed about the subject matter of the insurance by other underwriters, or by foreign correspondents. By way of sharp contrast, it is now settled by the decision of the Court of Appeal in Locker & Woolf Ltd v W Australian Insurance Co [1936] 1 KB 408 that an insured must report a rejection with regard to an entirely different type of insurance (for example, fire insurance) from the type he has now applied for (for example, motor insurance). The Court of Appeal in Locker seems to have been so impressed by the incantation of the phrase uberrima fides that it did not bother to deal with the highly relevant argument advanced by counsel for the insured: “If the insurance companies desire to have information as to other insurances, they should make this clear…” Further, the insurer may avail himself of the principle of uberrimae fides, even though he (the insurer) has put his question to the insured with regard to the previous rejections in an ambiguous form. This is the teaching of the

decision in Glicksman v Lancashire and General Assurance Co [1927] AC 139… …In the first place, a distinction should be drawn between on the one hand the insured’s duty to give details of previous refusals to insure him (or his property), and on the other the insured’s duty to give details of previous losses suffered by him (the insured). With regard to the first duty, it is submitted that the marine insurance rule, which does not recognise this duty, should be applied across the entire field of insurance law. This is so because information with regard to a refusal only tells the insurer to investigate his risk with great care. But this, one should have thought, only describes the insurer’s duty at the present time with regard to the investigation of all risks. In short, if an applicant for insurance has been rejected by a previous insurer for arbitrary or capricious reasons, it is monstrous to penalise such a person further by holding that his subsequent insurance is void because of his (the applicant’s) failure to disclose an earlier capricious refusal! On the other hand, if the applicant was rejected by an earlier insurer for good and sufficient reasons, it is presumably open to the subsequent insurer to ascertain by intelligent and searching questions what those reasons were. It does not require much argument to establish that an insured’s accident history will often be of greatest importance to an insurer. This fact, however, does not argue for a broad duty of disclosure; on the contrary, it is submitted that the duty of disclosure should be a very narrow one. In the first place, the information allegedly withheld must be closely related to the circumstances of the present loss in the manner described by Scrutton LJ in Becker v Marshall (1922) 11 Ll L Rep 114. Secondly, an insurer’s failure to ask questions with regard to losses should be regarded as a waiver of this information, as should the insurer’s acceptance of blank replies to questions in the proposal form (regardless of the form of the question).

Further, an insurer should not be allowed to take advantage of ambiguous questions in the proposal form. Finally, the insurer should not be able to render immaterial information material by the simple expedient of using a “basis of the contract clause”. This alternative unhappily appears to be open to an insurer. (2) Criminal convictions The small body of case-law requiring the insured to disclose previous criminal convictions is worthy of note, principally because it illustrates the ludicrously unjust results that are liable to occur from the application of an unsound rule. By way of example, consider the decision of the Court of Appeal in Schoolman v Hall [for the facts see Cohen LJ’s judgment, above, [409]]… Happily, in…Roselodge Ltd v Castle [1966] 2 Lloyd’s Rep 113, some limit seems to have been set to the duty to disclose in this area [the facts are summarised above, [414]]… Essaying his own evaluation of the materiality of the two convictions, McNair J decided that R’s conviction in 1946 was not material, since it had “no direct relation to trading as a diamond merchant”. His Lordship held that in the case of M’s conviction there was such a “direct relationship” and it must be regarded as material. Although this holding obviously represents a more enlightened approach than that demonstrated in the two earlier cases discussed in this section, it is submitted that, on the facts in Roselodge Ltd v Castle, the insurer should have been held to have waived the information relating to M’s previous conviction. Remarkably enough (given the type of insurance involved in this case), the insurer in Roselodge Ltd v Castle did not ask M any questions relating to moral hazard. To require the court to step into the breach, as it were, means that in the first place, the court may have to make an extremely difficult decision with regard to the materiality of a

particular fact when it lacks both the requisite knowledge to make this determination, as well as adequate means for obtaining such knowledge. Secondly, and perhaps even more seriously, permitting a judge to “second guess” an insurer tends to dilute the well established and essential duty of the insurer to make the relevant inquiries of the insured…

Critique It is now possible to summarise briefly the various defects of the uberrima fides as it exists today. In the first place, current doctrine, so far from representing a restatement of classical doctrine as set out in decisions such as Carter v Boehm, sets out an entirely different principle, one largely fashioned during the present century. It is respectfully submitted that Carter v Boehm was correctly read by a number of American courts in the 19th century who read the case as stating a “narrow” rule of disclosure. More seriously, it is clear (in words of the Law Reform Committee Report on Conditions and Exceptions in Insurance Policies) that “…a fact may be material to insurers…which would not necessarily appear to a proposer for insurance, however honest and careful, to be one which he ought to disclose”. Further, the doctrine seems to work harder against laymen than against professionals. The “marine” professional is in the strongest position: in the first place, he does not, as we have seen previously, have to disclose information that has to be disclosed by other classes of applicants. Secondly, it would appear that the courts are more ready to infer a waiver of information by the insurer in a marine insurance situation than in other insurance situations. The land based professional does not occupy as privileged a position as his marine cousin but he would still appear to be in a stronger position with regard to

the working of the doctrine than in the layman who applies for, for example, life insurance. In the first place, the professional is more likely to know that a duty to disclose exists and to know also what information the insurer needs to know, than is likely in the case with a lay applicant for life insurance. Secondly, it is likely that an applicant for life insurance will be asked more questions (some of them relating to his health, a matter in which he has no expertise) than will be true in the case of a businessman taking out a policy against fire or burglary. Thirdly, the doctrine is in error in assessing the strength of the parties with regard to knowledge. The doctrine assumes that the insured is in a stronger position than the insurer because he (the insured) has more knowledge than the insurer. But the possession of greater knowledge, it is submitted, puts the insured in a weaker position, since he (the insured) does not know which parts of that information the insurer wishes to have. It is submitted, however, that it is the insurer who should be seen as the stronger party, since he (the insurer), is aware of what information he seeks to have. As against this, the insured, even though under the limited formulation of the doctrine, requiring him to disclose only facts within his knowledge, may wellbe in the position of either not knowing, or else being uncertain as to the materiality of a particular fact…

Notes on reform It is not within the scope of this paper to offer detailed statutory provisions but some general — if disconnected — remarks on the shape such reforming provisions might take would appear to be in order… …Turning…to the form revised disclosure provisions might take, it is submitted that, while foreign legislation should obviously be consulted, great care be taken in borrowing

statutory provisions. The statutory provisions of many American States, to take but one example, are too brief for English conditions. The brevity of these statutory provisions is to be explained by reference to two very closely connected factors. In the first place, very often the statutory provision will represent no more than codification of the preexisting common law position. But, even where this is not the case, a brief statutory provision will be interpreted in the light of a general judicial solicitude for the position of the insured. The fact that these circumstances are not present in England makes it advisable that any statutory provisions go into far greater detail than any potential foreign model appears to do. Without being exhaustive, a model disclosure statute might well provide for the following. In the first place, it might be desirable to provide that an insured is under no obligation to provide information with regard to certain matters. As examples of such “classified” information could be included an applicant’s race or nationality; further, the insured should be deemed to be under no obligation to reveal that he has previously been refused insurance. The key provision in the statute should state in the clearest possible language that any failure by an insurer to ask of an insured information customarily sought by insurers in the type of policy in question should be deemed a waiver of such information. The burden of proof to show that a particular piece of information was so esoteric as not to have been ascertainable by ordinary inquiry should again clearly be placed on the insurer. The adoption of the above-described waiver principle should reduce the insured’s duty of disclosure to (justly) narrow limits. With regard to the disclosure of this “unascertainable” information, the insured should be penalised only if he acted in “bad faith,” ie, if he knew, or had very good cause to believe that a particular piece of

information would in fact be material to the insurer. The burden of showing “bad faith” should again be placed on the insurer. The insured’s duty of disclosure should also be recognised in another situation, namely, when the insured comes into possession of material information between the time of the application for a policy and the time the policy is issued. If American case law is any guide, disputes arise more frequently over the duty to disclose in this situation than is true of the insured’s duty to disclose “unascertainable” information. The duty to disclose such information should be recognised (as it is in American law), except that the policy should be made to spell out clearly that such an obligation exists. It is, it is submitted, all too easy for an insurance applicant to think that a contract has been concluded at the time the policy was applied for. Again, it might be desirable to expressly provide for the contra proferentem principle in a separate provision. Perhaps more valuable than such a provision would be one stating that the insurer is responsible for any ambiguities in questions asked in the application. Indeed, the situation in Glicksman v Lancashire and General Insurance Co… could be set out, with, of course, a different outcome indicated. Finally, even with a much limited duty of disclosure, it is still desirable to provide that an insurer prove clearly the materiality of some particular piece of information that has been withheld. In particular, serious consideration should be given to reforming the manner in which expert evidence is given, so that the responsibility for ascertaining insurance practice become the responsibility of the court, instead of being left, as at present, to the unequal struggle between the parties. Such a system would not attain complete objectivity since obviously most expert testimony will continue to be given by underwriters, but it will at least make it impossible for an insurer to hand pick his experts or to call “experts” from the insurer’s own company…’

[430] Law Commission Report No 104, Insurance Law — Non-Disclosure and Breach of Warranty, Cmnd 8064 (London, HMSO, 1980) Abolition of the duty with respect to consumers 4.34 Having rejected the suggestion that the duty of disclosure should be totally abolished, we must now consider the proposal, which was advanced by some of those whom commented on our working paper, that it should be abolished with respect to consumers. These commentators urged that consumers as a group should be treated differently from commercial undertakings. In particular, it was suggested that consumers should be under no duty to volunteer material information to insurers and that if insurers wanted such information, they should ask for it. In the paragraphs which follow, we shall adapt the definition of ‘consumer’ used in section 12 of the Unfair Contract Terms Act 1977, in the case of contracts other than contracts for sale or hire purchase: we intend ‘consumer’ to mean a person who neither makes the contract in the course of a business nor holds himself out as doing so. Thus, a shopkeeper living in a flat above his shop would insure his shop and its contents as a businessman, but his flat and its contents as a consumer. 4.35 In our working paper, we rejected any distinction between consumers and non-consumers on the ground that the arguments in regard to ‘sharp practice’ against the total abolition of the duty of disclosure apply equally to the proposal that it be abolished with regard to consumers only. For example, in the absence of any duty of disclosure the insured could apply for cover on his premises without revealing that a threat had been made to bum them down. This result would be unacceptable even if the prospective

insured were a consumer applying for insurance on his house. 4.36 The basis for any differentiation between consumers and nonconsumers must be that the more lenient treatment of a particular category is justified because that category is in need of special protection. As explained in our working paper, there are certain mischiefs in the law of nondisclosure which apply equally whether the insured is a consumer or a businessman who is not constantly concerned in his business activities with the insurance market. Neither consumers nor ordinary businessmen who are not in the insurance market have the knowledge or experience to identify all facts which may be material to insurers. Both are therefore to this extent in need of protection and both may properly be regarded as consumers vis-à-vis insurers. 4.37 It may also be contended that it is unfair to consumers to subject them to a duty of disclosure since they may be totally unaware of the duty or of the consequences of breach of the duty. However, many small businesses are equally unlikely to be aware of the niceties of insurance law when applying for insurance. Similarly, consumers are on the whole considered less likely than businessmen to take advice — for example, from insurance brokers — which might reveal the existence and extent of the duty. But the well off or cautious consumer may as a matter of course seek the advice of an insurance brokers — which might reveal the existence and extent of the duty. But the well off or cautious consumer may as a matter of course seek the advice of an insurance broker when in need of cover, while the small businessman may not. It is however impracticable to draw a line between those who consult brokers and those who do not. This is not to say that a person’s need for protection may not depend on his situation and the circumstances in which he enters into the contract. For example, if a large business corporation enters

into a contract for the supply of goods or services it will usually appreciate the nature and consequences of the transaction far better than a small business or a private individual. Thus, there may well be a sensible dividing line between those insured who are in need of special protection and those who are not, but in our view this dividing line should be between ‘professionals’ and ‘non-professionals’. The exclusion of MAT [marine, aviation. transport] insurance from the scope of our recommendations reflects this distinction. 4.38 Furthermore, if a special regime were devised for consumers, there would be three categories of insured to each of which different rules would apply. Those insured against MAT risks would be excluded from the scope of our recommendations and would be regulated by the present law; non-consumers would be subjected to a modified duty of disclosure, and consumers would be exempted from any duty. This multiplication of legal categories would clearly be complex and undesirable. 4.39 A further reason against differentiating between consumers and non-consumers is connected with the fact that the vast majority of consumer insurance is written on the basis of proposal forms. As we point out below, the present law in relation to proposal forms is defective in certain respects. In particular, we think it likely that many applicants, regardless of whether they are consumers or businessmen, who have completed a proposal form may erroneously believe that they are under no duty to disclose further information, and, in our view, such a belief will usually be perfectly reasonable. For this reason, we have made detailed recommendations in this report in order to protect applicants for insurance who complete such forms. These recommendations are in effect measures of consumer protection. But the use of proposal forms and the mischiefs associated with them are not confined to consumer insurance; to this extent our recommendations also protect

businessmen, and, in our view, it is right that they should do so. 4.40 Finally, if the duty of disclosure were to be wholly abolished for consumers, the granting of provisional insurance cover prior to the completion of a proposal form would give rise to difficulties. This type of cover is often granted to consumers. For example, insurance cover for motor vehicles is often granted over the telephone by a broker and a cover note is then issued. Similarly, house insurance cover is often granted over the telephone where the insured has just exchanged contracts for the purchase of a property. In the absence of any duty it would be open to a prospective insured to conceal any information which he knew to be material but which was unusual in its nature, so that the insurer or broker could not reasonably be expected to ask about it over the telephone. As we pointed out in our working paper, while insurers might not withdraw facilities for such cover they might well increase premiums, and might also insert a greater number of conditions and exceptions into their policies to narrow the scope of the risk covered.

Attenuation of the duty of disclosure with respect to consumers 4.41 It was suggested to us that in relation to cover obtained by consumers, insurers should not be entitled to repudiate a policy unless the non-disclosure was fraudulent. We think that it would only be in exceptional cases that an insurer would be able to discharge the onus of proving that an applicant for insurance omitted to volunteer a material fact with the intention of deceiving him. Even where there has been a misstatement in the proposal form, the onus of proving fraud is difficult to discharge. We think that such an attenuation would be unacceptable. Like the proposal to abolish any duty of disclosure with respect to consumers, it would create three categories of policyholders to each of

which different rules would apply, with resultant multiplicity of legal categories and undesirable complexity… 4.42 In the result, it seems to us that any separate regime for consumers and nonconsumers would lead to anomalous results in practice. This can again be illustrated by a shopkeeper who lives above his shop. He applies for fire and burglary cover in respect of both his shop and his flat at the same time: the former application would be made in the course of a business, but the latter would not. It would be odd, to say the least, if the resulting contracts were subject to different vitiating factors. We are persuaded by all these cumulative considerations that there should be no special category of consumer insurance to which more lenient rules should apply…

The duty of disclosure 4.47 We recommend that the duty of disclosure imposed on an applicant for insurance should be modified as follows. A fact should be disclosed to the insurers by an applicant if: (i) it is material to the risk; (ii) it is either known to the applicant or is one which he can be assumed to know; (iii) it is one which a reasonable man in the position of the applicant would disclose to his insurers, having regard to the nature and extent of the insurance cover which is sought and the circumstances in which it is sought. It will be seen that this formulation departs somewhat from that put forward in our working paper. In the following paragraphs, we will elaborate the elements of the modified duty of disclosure.

A fact which is material to the risk 4.48 A fact must be material to the risk before there can be any question of a duty to disclose it to the insurers. We

propose that the definition of a material fact should remain substantially the same as in the present law. Thus a fact should be considered as material if it would influence a prudent insurer in deciding whether to offer cover against the proposed risk and, if so, at what premium and on what terms. This definition amplifies the present one, which only refers to the prudent insurer’s decision to accept the risk and to his premium rating of the risk. Insurers may, however, react to the disclosure of material facts otherwise than by refusing the risk or altering the premium: they might, for example, insert additional warranties, increase the ‘excess’, or narrow the scope of the risk by exclusion clauses. The revised definition takes these additional factors into account by referring to terms other than the premium upon which the insurers would be prepared to offer cover.

A fact which is known to the proposer or which he can be assumed to know 4.49 No duty to disclose a material fact will arise unless that fact is known to the proposer or can be assumed to be known by him…We do not consider that it would be acceptable for the insured to be required to disclose all material facts without regard to whether such facts were known or ought to have been known by him, since an insurer would then be entitled to repudiate the contract for the non-disclosure of a fact outside the insured’s knowledge or means of knowledge. Equally, it seemed to us in the working paper that it would not be acceptable for the insured to be able to say that he has complied with his duty of disclosure if he did not actually know a fact, even when that fact was obviously relevant and easily ascertainable by him. On consultation, few commentators referred specifically to the question of constructive knowledge and opinion was divided amongst those who did. 4.50 In our view, an insured should not be entitled to say that he did not know facts which were obviously relevant

and easily ascertainable by him. However, the insured should clearly not be obliged to mount elaborate investigations within the whole spectrum of material facts. What we recommend is that he should be assumed to know a material fact if it would have been ascertainable by reasonable enquiry and if a reasonable man applying for the insurance in question would have ascertained it.

A fact which a reasonable man in the position of the proposer would disclose to the insurer, having regard to the nature and extent of the insurance cover which is sought and the circumstances in which it is sought 4.51 Even if a fact is material to the risk and is known to the proposer or can be assumed to be known by him he will only be obliged to disclose it to the insurers if a reasonable man in his position would disclose it. The words, ‘in the position of the proposer’, would allow the courts to have regard to the knowledge and experience to be expected of a reasonable person in the position of the applicant. Thus, more would be expected of the large company with an insurance division than of the small shopkeeper. On the other hand, we would not wish the court to take account of the individual applicant’s idiosyncrasies, ignorance, stupidity or illiteracy in determining whether a reasonable man in his position would disclose a know material fact. Our formulation would only direct the court’s attention to the nature and extent of the insurance cover which is sought and to the circumstances in which it is sought. Thus, a reasonable man applying for life insurance would not disclose facts relevant to his house or his car. Equally, a reasonable man applying for householder’s cover would not disclose facts relevant to his health. The court would also have regard to whether the cover applied for was only provisional or temporary, since a reasonable man would not necessarily disclose the full spectrum of known material facts when applying for merely temporary cover. In addition,

the extent or magnitude of the proposed risk would be relevant. Thus more would be expected of a businessman applying for insurance on a factory full of machinery than would be expected from a householder insuring his house and its contents. 4.52 Our formulation would also concentrate the court’s attention on the circumstances in which insurance cover was sought. Thus a reasonable man applying for insurance over the telephone might well address his mind to the disclosure of material facts to a different extent than if he were making a written proposal for insurance. Equally, in negotiating the cover the insurers may have given the insured the impression that on certain aspects material facts need not be disclosed in full or at all; in such cases the insured may assume that they are waiving disclosure of matters concerning which they appear to be indifferent or uninterested in an illness suffered six years ago. Another example of a case where waiver could be inferred is provided by “coupon” insurance. This type of insurance can be obtained either by inserting the required amount of money into a machine, as happens mainly at airports, or by completing a very simple application form which asks only for the name, address and occupation of the applicant. The “coupon” itself is a document which may either itself be a contract of insurance or an undertaking to issue a policy. In such cases there would seem to be no duty of disclosure, since the applicant is unlikely to have any occasion to disclose anything. By making an offer to the public which is capable of being accepted by anyone, the insurers in such cases in effect indicate that they are willing to insure anyone regardless of his antecedents or characteristics. Another example is provided by the issue of immediate or interim cover, usually in connection with motor vehicles. It is usual in such cases for insurers to require an applicant to complete a proposal form at a later stage, and a reasonable applicant might therefore assume that the insurers were at

this stage not interested in the disclosure of material facts which would be relevant only to the premium-rating and not to the question whether the risk should be accepted. In all such cases, the position is that the insurers have adopted a procedure whereby cover is applied for and granted in such a way that a waiver as to the disclosure of material facts may be inferred. Under our recommendations, all such matters could be taken into account by the courts in determining whether or not there had been a material nondisclosure…

The duty of disclosure in relation to proposal forms 4.56 A major criticism of the present law…is that an insured may well be unaware that he is under a residual duty to disclose material facts to the insurer when he has answered a series of specific questions in a proposal form, because these could naturally lead him to believe that the questions cover all matters about which the insurer is concerned to be informed. Indeed, the very fact that specific questions are invariably asked in proposal forms, which is their essential purpose, may have the effect of creating a trap for the insured under the present law. We have no doubt that this is a mischief which requires reform for the protection of the insured. 4.57 In the working paper, we made the provisional recommendation that this protection should be provided by confining insurers to the answers to specific questions asked in proposal forms and that they should be treated as having waived the disclosure of any information to which no specific question had been directed. Consequentially to this, we also provisionally recommended that no general questions in addition to specific questions should be permitted, such as a question whether there were any other facts which might influence the judgment of a prudent insurer in accepting the risk and fixing the premium The effect of these recommendations would be to confine

insurers to specific questions in all cases in which proposal forms are used and to abolish any residual duty on the insured beyond answering the questions… 4.58 In the comments received on consultation, our provisional recommendations were criticised on the ground that the purpose of proposal forms was to elicit information of a standard nature and not to circumscribe the nature of the risk in all respects. It was pointed out that the effect of our provisional recommendations would be that proposal forms would inevitably have to become far more lengthy, detailed and complex than at present and, further, that proposers might well be aware of facts which any reasonable person would realise should be disclosed but about which insurers could not reasonably be expected to ask specific questions. We accept these criticisms. For instance, a person might take out product liability insurance when it appears to him that his quality control is inadequate but he does not know the reason, or a businessman might effect some special fire cover on his premises when he has reason to believe that they might be burned down. Such cases could not possibly be expected to be covered by specific questions in proposal forms. They would of course be covered by a general question, such as we have instanced above, which is indeed commonly included as normal underwriting practice in many kinds of proposal forms at present. The effect of a general question of this kind is that the insured is placed under a residual duty to volunteer further information, though with the advantage of having had his attention drawn specifically to this duty. On further consideration we see no reason to outlaw such general questions; indeed, it seems to us that they can be said to fulfil a useful purpose, and they may indeed be essential in many cases. This is the first reason why we consider that it would be impracticable to confine the duty of the insured in relation to proposal forms simply to

supplying answers to specific questions and thus to eliminate any residual duty of disclosure. 4.59 The second crucial matter to bear in mind on the question whether it would be right to abolish any residual duty of disclosure in cases where proposal forms are completed is that the effect of the recommendations which we have already made is to reduce the level of the duty of disclosure to that of the reasonable insured in all cases (other than MAT insurances), whether proposal forms are used or not. It follows that, under our recommendations, no insured will have been in breach of his duty of disclosure in any event unless ex hypothesi he has fallen below this standard. The effect of this recommendation is therefore that it also greatly reduces the remaining problems concerning non-disclosure in cases of proposal forms. Nevertheless, there still remains the problem that in cases of proposal forms, particularly where no general question is asked in addition to specific questions, a proposer is likely to be unaware that he may be under a further residual duty to volunteer additional material information. It may well be, of course, that in the absence of a general question the courts might hold in the particular circumstances of some cases that a proposer could reasonably assume that he was under no further duty beyond answering the specific questions; on this basis the effect of our recommendations will be that in such cases he will have discharged his duty of disclosure by answering the questions. However, we do not think that this is sufficient; in our view, the interests of both parties require that various matters concerning the insured’s obligations when he completes a proposal form should be drawn specifically and explicitly to his attention. 4.60 In our view, the solution to the foregoing problem lies in the requirement that all proposal forms should contain certain clear and explicit warnings to the insured, presented in a prominent manner, together with appropriate sanctions wherever such warnings have not been given. In many

cases, proposal forms already contain some warnings of the kind which we have in mind, and we see no administrative or other difficulties in requiring them to be included as a matter of law and providing for appropriate legal consequences if they are omitted. However, before dealing with these matters at greater length we must deal with two further topics; the standard which should be required from an insured in answering questions in proposal forms, and the necessity to supply to the insured a copy of his completed proposal form for future reference, particularly in relation to renewals of the cover.

Standard of answers to questions in proposal forms 4.61…We therefore recommend that an applicant for insurance should be considered to have discharged his duty of disclosure in relation to the answers to specific questions if, after making such enquiries as are reasonable having regard both to the subject matter of the question and to the nature and extent of the cover which is sought, he answers the questions to the best of his knowledge and belief. This formulation would allow the court to take account of the particular topic raised by a specific question when assessing what enquiries ought to have been made into that topic. Further, the nature of the topic itself would be relevant. Thus, enquiries as to the materials of which a factory roof is constructed would obviously need to be more extensive than those concerning the cubic capacity of the engine of a motor vehicle…This recommendation is along lines similar to those suggested by the Law Reform Committee in their Fifth Report, in which the Committee formulated the following rule which, in their view, could be introduced into the law without difficulty: “…that, notwithstanding anything contained or incorporated in a contract of insurance, no defence to a claim thereunder should be maintainable by reason of any misstatement of

fact by the insured, where the insured can prove that the statement was true to the best of his knowledge and belief.” 4.62 In the foregoing paragraph, we dealt with the standard required from an insured when answering specific questions in a proposal form. To complete this aspect, it remains to mention the standard which is to be required from him when he answers a general question at the end, such as whether there are any other facts which might influence the judgment of a prudent insurer in accepting the risk and fixing the premium. We think that the standard required from the insured in answering such questions in proposal forms should be assimilated in all respects with out basic recommendation concerning the reduced standard required from proposers in relation to their general duty of disclosure: viz, they are under no higher duty than to disclose material facts which they know or are to be assumed to know and which would be disclosed by a reasonable person in the position of the proposer, having regard to the nature and extent of the insurance cover which is sought and the circumstances in which it is sought. Thus, for the avoidance of doubt we propose that the legislation which we recommend should also expressly provide that all general questions in proposal forms shall be construed as seeking no further information from the proposer than such information as he would be bound to disclose by virtue of the reduced duty of disclosure referred to above. We recommend accordingly. Copies of proposal forms to be supplied to insured 4.63 Next, we turn to a problem which is of particular significance when an insured is attempting to fulfill his duty of disclosure on renewal of his insurance. It was forcefully represented to us on consultation that the insured will often no longer remember the information which he supplied to the insurers on his initial application and on subsequent

renewals (if any), unless he is at least able to refer to a copy of his proposal form. In our view, insurers should be required to supply the insured with a copy of his completed proposal form…Further, in some cases there may be further communications between the insurer and the insured after the proposal form has been filled in, in the course of which the insured may supply further written information to the insurer, either in amplification of an answer given or in regard to a matter not canvassed specifically in the proposal form. The insured should clearly also be able to refer to these matters on renewal, and we again consider that he should be warned of the importance of keeping copies for future reference of the information which he has supplied.

Warnings to be included in proposal forms 4.64 We have already explained that in our view all proposal forms should contain certain warnings to the insured and that these should be presented in a prominent manner. We can now summarise the warnings which we recommend should be required to be included in all proposal forms in this manner. These should warn the insured: (i) that he must answer all questions to the best of his knowledge and belief, after making such enquiries as are reasonable in the circumstances; (ii) that in relation to any matter which is not the subject of a question in the proposal form, he must disclose any matter which he knows or could ascertain by reasonable enquiry and which might reasonably be considered to influence the judgment of a prudent insurer in deciding whether or on what terms to provide the cover which is sought; (iii) of the consequences to the insured of a failure to fulfill the obligations referred to in (i) and (ii) above, that is, of the insurer’s right to repudiate the policy and to reject any claim which may have arisen; and

(iv) of the importance to the insured of keeping the copy of the completed proposal form which will have been supplied to him under our recommendations and of any additional information which he may give to the insurers.

Sanctions if any of the requirements concerning proposal forms are not complied with 4.65 We have already mentioned that it is clearly necessary to provide sanctions against insurers in cases in which any of the prescribed warnings are omitted or are not presented in a prominent manner. Similarly, sanctions will clearly also be necessary if an insurer fails to comply with the obligations which we have recommended to supply to the insured a copy of the completed proposal form. We therefore turn to this aspect. 4.66 Since we foresee no real difficulties for insurers in complying with the foregoing recommendations, which are in any event already widely adopted so far as concerns warnings about the duty of disclosure and the standard for answering questions in proposal forms, we consider that there should be a clear and substantial sanction for cases in which there is a failure to comply with these requirements. They are all directed to seeking to assist the proposer to discharge his obligation to disclose material facts to the insurer, whether by answering questions in proposal forms or by complying with any residual duty of disclosure which might still subsist. In these circumstances we consider that the appropriate sanction is that if there is a failure to comply with any of these requirements the insurer shall not be entitled to rely on any failure by the insured to disclose any material fact, and we so recommend. 4.67 However, there may be cases in which the stringency of this sanction would be inappropriate because it may be quite clear that some trivial failure on the part of the insurer will not have caused any prejudice to the insured in relation

to any failure of disclosure on his part. For instance, the insurer may have failed to provide the insured with a copy of the proposal form, but the insured may have kept his own copy…In such cases it may be quite clear that the nondisclosure of some material fact has had no connection with some particular failure on the part of the insurer to comply with the requirements. We think that some additional provision should be made for exceptional cases of this kind. We accordingly recommend that, where there has been a failure by the insured to disclose a material fact, in circumstances in which the court is satisfied that a failure on the part of the insurer to comply with the requirements did not cause any prejudice to the insured with regard to his obligation to disclose such fact, then the court may give leave to the insurer to rely on the non-disclosure in question…

Renewals Introduction 4.69 Having dealt with the topic of disclosure in the context of proposal forms we now turn to deal with it in relation to renewals. In this context, the topic is of great importance because the vast majority of insurance contracts made in England are by way of renewal of existing policies, with the result that the duty of disclosure will most often arise on applications for renewed cover. The reason is that most insurance policies in England, other than policies of life insurance, are contracts for a term of one year and are renewable annually. In relation to such contracts the parties usually envisage that the contract will be renewed each year…

Reform of the duty of disclosure on renewal 4.72 Earlier in this report we concluded that, to put it shortly, an insured should on an original application for insurance, be under a duty to disclose only those material facts which, having regard to the particular circumstances, a reasonable man would disclose. On this basis, we consider that it would be clearly unsatisfactory if an insured were under a more onerous duty of disclosure on renewal than when he made his original application, and in our view the same standard of duty should clearly apply. On the other hand, since an insured is under no obligation to disclose matters which are already known to the insurer, on renewal the insured will only be obliged to update the matters disclosed when the contract was concluded or on the occasion of the last renewal, as the case may be. The effect of this, and of our recommendation about the general duty of disclosure, will therefore be that on renewal the insured will have to disclose material facts which he knows or is assumed to know, which have not been disclosed by him and which would be disclosed by a reasonable insured in his position, having regard to the nature and extent of the cover which is renewed and the circumstances in which it is renewed… Should the insurer’s rights in disclosure be further restricted?

respect

of

non-

Introduction 4.88 In the following paragraphs we will consider whether the balancing of the interests of the insurer and the insured requires that the insurer’s rights in respect of non-disclosure by the insured should be still further restricted than on the basis of the recommendations which we have already made. We consider two possible further restrictions. The first would

preclude the insurer from rejecting a claim if the insured could prove that there could have been no connection between his non-disclosure and the loss. The second would leave the remedy for non-disclosure to the discretion of the court and would thus allow the insured who is in breach to make partial or total recovery of his claim in some cases. We deal with proposals in turn.

Connection between the non-disclosure and the loss 4.89 In our working paper, we dealt with the question whether our provisional recommendations should go further to protect the insured on the basis that insurers should only be entitled to reject a claim on the ground of non-disclosure of a material fact if the undisclosed fact is in some way connected with the loss. We refer to this hereafter for convenience as a “nexus test”… 4.90 In our working paper, we provisionally recommended that the law of warranties should be reformed so that rejection of a claim for breach should only be allowed if there is a connection of some kind between the insured’s breach and the loss. We adhere to this recommendation in this report. In the context of non-disclosure the precise formulation of a nexus test would require separate consideration, but for the purpose of the present discussion it is sufficient to put the issue in broad terms. Suppose that an insured has failed to disclose a material fact, that is, one which would have affected a prudent insurer’s decision whether or not to accept the risk at all or, if so, at what premium and on what terms. Suppose also that a loss subsequently occurs which could not have had any connection with the undisclosed fact. Although the insurer would be entitled to repudiate the policy, should the insured nevertheless be entitled to recover his claim? 4.91 At first sight this result may appear to be just, as some of our commentators felt. However, on examination it is clear that the insurer would thereby be held to a contract

which he would either not have accepted at all, or only at a higher premium or subject to different terms, or both. This would appear to be unfair. For this reason and for the reasons set out in the paragraphs below, we have concluded that, whatever superficial attraction the nexus test may have in the context of non-disclosure, it is misconceived and should not be adopted in this context. 4.92 One must begin by putting the issue into the perspective of our other recommendations in this report in order to see the extent of the problem which would remain if these are adopted. Our present law of non-disclosure has caused hardship and led to widespread criticism, as we have already pointed out. In particular, we have identified the following mischiefs with which we have already dealt, viz: (a) that the standard to be applied to the duty of disclosure is that of a prudent insurer and not of a reasonable insured; and (b) that in proposal form cases it may well not occur to the proposer that in addition to answering a large number of questions he is required to volunteer material information without his attention having been drawn to this obligation in any way. However, under our recommendations these mischiefs will disappear. By applying the test of a reasonable insured, many of the ‘moral hazard’ cases, which have been subject to particularly strong criticism, may in any event be decided differently. Further, in proposal form cases, which in the present context in our view present the greatest mischief in practice, the insured will have had his attention drawn expressly to his duty to volunteer material information. If the insurer has failed to give the necessary warning, he will not be entitled to rely on the nondisclosure of such information. 4.93 For present purposes one therefore starts with cases concerning proposers who will, ex hypothesi, not have acted in the way in which a reasonable person in the position of the insured would have acted. On this basis, the considerations of justice concerning the consequences of a

non-disclosure at once assume a different aspect. But then one comes to a further consideration. Suppose that a proposer unreasonably fails to disclose some material fact under the rubric of “moral hazard”: how could the application of a nexus test work in practice? Suppose that an applicant fails to disclose a bad claims record or (unspent) convictions for dishonesty: such facts could, in practice, hardly ever be shown to have had any connection with a particular loss. The result would be that an insured who is unreasonably in breach of his duty of disclosure would, in such cases, virtually always recover. We do not think that this would be acceptable or that it strikes a fair balance between insured and insurer against the background of the reforms of the law of non-disclosure which we are recommending. 4.94 There is a further and perhaps even more fundamental objection to the introduction of a nexus test into the law of disclosure which applies whether or nor the undisclosed material fact concerns “moral hazard”. This objection stems from comments which we received from the insurance industry on consultation which have greatly impressed us. Unlike cases of breach of warranty, in relation to which we are recommending that there must be a connection between the breach and the loss, all considerations relating to non-disclosure must focus on the moment when a proposal for insurance is put forward and either accepted on certain terms or rejected, in either event by reference to what the insurer judges to be the quality of the risk. The technique — one might almost say the art — of good underwriting is to judge all the factors affecting an offered risk at this moment, when the underwriter must then and there assess its quality on the basis of his experience, as though he were considering the overall impression given by a “still photograph” of the risk at this point. In these respects, the implications of nondisclosure are quite different from those of breaches of warranties

during the currency of the cover. As a result of the nondisclosure, the insurer will have accepted a risk which, had he known all the material facts, he would either not have accepted at all or would have accepted at a different premium or on different terms. In these circumstances, we see great force in the contention made on behalf of the industry that it would be wrong in principle to hold the insurer to the contract in such cases. Furthermore, under our recommendations made later in this report we severely curtail the rights of insurers to rely on ‘basis of the contract’ clauses as a means of avoiding liability, with the result that their rights in cases of non-disclosure would assume even greater importance than at present. 4.97…we [therefore] recommend against the introduction of a nexus test in relation to non-disclosure…

[431] The Australian Law Reform Commission Report No 20, Insurance Contracts (1982): Chapter 6 Non-disclosure and Misrepresentation.

Conclusion 183. The existing duty of disclosure is not justified by the principle of uberrimae fides. That principle would appear to suggest that an insurer should only be entitled to redress in the event of deliberate concealment or culpable indifference. A former member of the Commission` was firmly of this view. However, the existing members are concerned that a rule based on concealment might give rise to unwarranted difficulties of proof and might conceivably make dishonesty more difficult to detect. They therefore recommend that the duty of disclosure should be retained in modified form. An insurer which wishes to rely on innocent

non-disclosure should warn the insured of his duty of disclosure before the contract is entered into. The duty should itself extend to facts which the insured knew, or which a reasonable person in the insured’s circumstances would have known, to be relevant to the insured’s assessment of the risk. The substance of the test suggested in the English Law Commission’s working paper is preferable to that which the Law Commission espoused in its final report. Fairness to the insured can only be achieved by taking account of those differences between individual insureds which the Law Commission’s final recommendation would exclude from consideration. Literacy, knowledge, experience and cultural background are ad vitally important factors affecting the behaviour which can reasonably be expected of insureds, both by insurers and by the legal system which regulates the insurance relationship. Insurers sell to a wide market. They often do so with a minimum of formality. Subject only to the principle of utmost good faith, they must take the individual members of the relevant market as they find them. The existing requirement of disclosure imposes obligations on those individuals which many of them, acting in the utmost good faith, are unable to discharge. Marketing methods are adopted which increase the risk of non-disclosure. Where intermediaries are not involved, there is no one to bring the insured’s obligation to his attention. For reasons of cost and competition, proposal forms are often kept to a minimum. Relevant questions concerning the moral risk are not asked in case they should embarrass a prospective insured. The adoption of direct marketing techniques has increased the pressure for brevity and simplicity. Within the foreseeable future, insurance, like many goods and services, may be purchased by means of computer-based communications systems. All these developments increase the risk of occasional innocent nondisclosure by an unsuspecting member of the public. That risk is one which should be borne by all insureds. The

insured’s “particular circumstances” are primarily within his knowledge rather than that of the insurer. He should be required to establish the existence of any circumstances which he relies on to reduce the scope of his duty to disclose. In view of the infrequency with which insurers exercise their rights to avoid a contract for non-disclosure, the risk of non-disclosure is already largely being borne by all insureds. Because there are so many insureds and because the combination of non-disclosure and subsequent loss is so infrequent, the effect of the proposed change on premiums would be negligible.

Misrepresentation General Insurance 184. The duty not to misrepresent facts is acceptable in principle. It becomes unacceptable when the materiality of the facts misrepresented is rendered irrelevant by a basis of contract clause. That type of clause should be rendered ineffective…

Remedies for Breach Insurance and Other Contracts 187. The remedy of avoidance or rescission of a contract is not unique to insurance. But there is a vital difference between the operation of that remedy in insurance and its operation in relation to other contracts. Avoidance of a contract for, say, the sale of land does not usually result in great hardship to either party. The vendor regains his

interest in the land; the purchaser recovers his money. But avoidance of an insurance contract normally takes place after a loss has occurred and a claim has been made. In such a case, It inevitably results in a loss which may well be overwhelming. The principle of restitutio in integrum is satisfied only in the most technical sense. The insured gets back his premium and the insurer is freed from its obligations. But that does not put the parties back into the substantial position they were in at the time of the contract; at that time, the insured had not suffered an uninsured loss. In many cases, the insurer’s remedy is out of all proportion to the harm caused by the insured’s breach of duty. These considerations suggest that a limitation should be placed upon an insurer’s right to avoid a contract for non-disclosure or misrepresentation. The limitation which suggests itself is the substitution of a right to damages for the existing right of avoidance. That would provide an adequate deterrent to misrepresentation and non-disclosure. It would also ensure that insurers were entitled to adequate compensation for loss suffered as a result of breach of the insured’s duties. Disproportionate burdens would no longer be placed on the insured. Even so, an important problem arises: the method by which damages should be assessed.

Assessing Damages 188. Proportionality France and the EEC. There are several methods by which damages for misrepresentation and nondisclosure might be assessed. First, normal contractual principles might be used. On this approach, the misrepresentation or non-disclosure would notionally be treated as a term of the contract of insurance. An insurer would be entitled to recover such damages as would compensate it for the loss it had suffered as a consequence of the breach of that notional term. Normally, those damages would be the difference between the cost to the insurer of bearing the risk it had agreed to bear — that is,

the cost of the risk if the representation were true or the fact which was not disclosed were false — and the cost to the insurer of bearing the actual risk — that is, the cost of bearing the risk given that the representation was false or the fact not disclosed was true. This appears to be the rationale behind the principle of proportionality which has been adopted in some European countries. Under French law, for example, an insurer is obliged to pay the proportion of the claim which the actual premium paid bears to the premium which would have been payable if the material facts had been disclosed [Code des Assurances (1930–76), Article 113–9]. In this way, any additional risk and the loss attributable to that additional risk is, in effect, borne by the insured. A more complex set of provisions was adopted in the Proposed EEC Directive on the Co-ordination of Legislative, Statutory and Administrative Provisions relating to Insurance Contracts, a directive aimed at harmonisation of the laws of the members of the EEC. Article 2 of the Proposed Directive deals with the insurer’s right in respect of innocent non-disclosure. It adopts the principle of proportionality only where non-disclosure is due to fault (short of fraud) on the part of the insured. In a case where the non-disclosure is not due to fault, the insurer would remain liable for any loss. 189. Difficulties. The adoption of either the French or the EEC approach would present two main difficulties. First, there would be cases in which it would be hard to establish what premium would have been payable if the undisclosed fact had been known by the insurer. It is clear that such a calculation could be made more readily in a country with a system of fixed tariffs. It is equally clear, however, that, even in Australia, it could be made with relative ease in life insurance and in certain areas of general insurance where individual insurers generally act on the basis of Axed categories and premiums. The calculation would be much more difficult to make in areas where the risks are unusual

ones or where the premiums are set on an ad hoc basis in response to competitive pressures. Similar difficulty would attend the setting of a notional premium where the undisclosed fact was connected with a moral or physical risk peculiar to the particular proposal, rather than with a matter of statistical importance. Secondly, there would be cases where the insurer would not have offered cover at all or would only have offered it on special terms, had it been aware of the undisclosed fact. In such a case, the premium which would have been charged could only be calculated by reference to the premiums which would have been charged by those insurers, if any, which would have accepted the risk. To make a calculation on that basis might be regarded as unfair to the particular insurer since it would be forced to accept a risk of a type which it had decided to exclude from cover. The only alternative would be to allow the insurer a complete defence when it was able to establish that, had the fact been disclosed, it would not have extended the cover sought. In its most recent form, the Proposed EEC Directive has adopted the latter approach, but only in the case of non-disclosure due to fault (short of fraud) on the part of the insured. 190. Proportionality: the English Law Commission. The difficulties noted in the previous paragraph, together with the danger that insurers might abuse a system based on their own recalculation of the premium, led the Law Commission, in its working paper, to conclude that neither the French system nor that subsequently set out in the Proposed EEC. Directive should be adopted in England. Although accepted by the British Insurance Brokers’ Association, this conclusion met with opposition from the British Insurance Association (BIA). The BIA was apparently willing to accept proportionality in order to facilitate the creation of a truly European insurance market. In its report, the Law Commission reaffirmed the stand taken in the working paper. It pointed to the difficulties experienced with

the operation of the principle of proportionality in both France and Sweden and to the fact that the strict principle has recently been abandoned in Sweden in relation to consumer insurance. It also noted that, even in France, there appears to have been a shift away from strict “arithmetical” application of the principle towards a discretionary reduction of the insured’s recovery. Finally, it re-emphasised the difficulties to which the principle would give rise in relation to setting the notional premium: Tables of tariffs can only correlate specific quantifiable factors, such as age, date of manufacture and so on with the premium to be charged. Thus in the straightforward but unusual case where there has been a misstatement of age in an application for life insurance or a misrepresentation as to the date of manufacture of a motor vehicle in an application for motor insurance, ascertainment of the notional premium should not be too difficult.…However, in the usual case where the undisclosed fact is qualitative rather than quantitative in nature — for example, failure to disclose a gastric complaint in an application for life assurance, or non-disclosure of a previous motoring conviction in an application for motor insurance — tables of tariffs will almost certainly he unable to assist, and disputes would proliferate into litigation with the inevitability of conflicting expert evidence as to what the notional premium should be. For the Law Commission, proportionality was defective in principle in that it concentrated on one term of the contract, the premium, to the exclusion of all others. It ignored the possibility that, had it known of the undisclosed fact, the insurer might have insisted on alteration to one of the other terms of the contract rather than on a simple increase in the premium. Similar criticisms of the principle of proportionality have been made in Australia. A number of general insurers have indicated their belief that the principle of proportionality would simply not work. It is understood that some life offices already informally apply such a

principle in relation to innocent non-disclosure within the three-year period before statutory incontestability. Indeed, section 83, Life Insurance Act 1945, is an Australian example, limited to misstatements of age, of the proportionality principle applied in the field of life insurance. 191. Causal Connection. A second way in which damages might be assessed in accordance with the contractual principle stated earlier is by allowing the insured to recover under the policy except where, and to the extent that, the breach of the notional term of the contract caused or contributed to the loss. Where the breach of the term was a partial cause, the insurer would be liable in respect of the loss, but only to the extent that the loss was not caused by the breach…While the test has considerable attraction in other contexts, it is doubtful whether it would be appropriate in the present one. Misrepresentation and non-disclosure relate to the truth of facts at particular times. For example, a representation that a motor vehicle was in good order and repair is a representation that, at the time the representation was made, the vehicle was in the stated condition. If, in fact, the representation was false and an accident subsequently occurred as a result of a defect in the vehicle, it is difficult to see how the falsity of the representation at the time the representation was made was a cause of the accident. The cause of the accident was the unroadworthiness of the vehicle at the time of the accident. Consequently, the insured would not, in the circumstances described, be disentitled from recovery by the causal connection test. There is a second difficulty with that test. The duty of dislosure and the duty not to misrepresent material facts enable an insurer to obtain information about the risk it is proposing to insure. Much of the information is relevant to the terms on which the insurer is prepared to provide cover against that risk. But the information is also relevant to the question whether the insurer in prepared to insure the risk

at all. For example, an insurer may only be prepared to insure buildings containing certain types of fire-fighting equipment. Under the causal connection test, if an insured made a relevant misrepresentation which induced the contract, the insurer would be liable for any loss, except one due to lack of the preferred equipment. And this, despite the fact that, had it known the true facts, the insurer would not have accepted the risk at all. 192. Common Law Damages. At common law, a different approach is taken to the assessment of damages for misrepresentation. Damages are only available in respect of fraudulent misrepresentation. They are assessed as the amount which would place the other party in the position he would have been in had the misrepresentation not been made. A similar principle has been adopted in those jurisdictions where the right to recover damages has been extended by statute to innocent misrepresentation. However, the relevant legislation also gives a court power, in cases where it considers it just and equitable to do so, to override a rescission for innocent or fraudulent misrepresentation, to declare the contract to be subsisting and to award damages. The legislation does not require a court to apply common law principles in assessing damages in such cases. Rather, the court is required to award such damages as it considers “fair and reasonable”. Either of these approaches might be used to assess damages for innocent misrepresentation and non-disclosure in relation to insurance contracts. Of the two, the common law approach is preferable. It is directed towards the parties themselves and does not require that discretions be conferred on a court. Damages for a breach of duty would simply depend on what the insured would have done had it known the true facts. Where the insurer would not have accepted the risk on any terms at all, the amount of its loss is clearly equivalent to the amount of the claim made against it. Where the insurer would have accepted the risk, but at a

different premium, its Ion is the difference between the actual and notional premiums. Where it would have accepted the risk on different terms (whether at the same premium or not), the loss is the difference between its liabilities under the actual and notional contracts. If it would have excluded the risk which gave rise to the claim, the amount of its loss is equivalent to the amount of the claim made against it. In that case, the insured would recover nothing…

Recommendations: General Insurance 194. The Principle. The nature and extent of the insurer’s redress should depend on the nature and extent of the loss which it has suffered as a result of the insured’s conduct. It should no longer be entitled to avoid a contract, and a heavy claim under that contract, merely because it has suffered a small, even insubstantial, loss as a result of a non-disclosure or misrepresentation. As the English Law Commission noted in its discussion of the proportionality principle, it is not always easy, in retrospect, to determine what the insurer would have done had it known the true facts. In numerous cases, however, the insurer would be able to establish, whether from rating guides, from its instructions to its agents or staff or from its prior conduct, the nature and extent of the loss which it had suffered. It is true that it would sometimes be difficult to establish how it would have reacted to additional moral, as distinct from statistical, risks. But difficulties of proof cannot be avoided if a proper balance is to be reached between the interests of the insurer and those of the insured. It is quite plainly contrary to the true principle of uberrima fides to impose on the insured a burden which far exceeds the harm which he has done. The insurer should not be entitled to any redress which exceeds the loss which it has in fact suffered. That is the basic principle which lies behind the law of damages, both in contract and in tort. It also lies behind the trend

towards restricting rights of rescission for innocent misrepresentation by allowing courts to override a purported rescission and to substitute an appropriate award of damages. An insurer’s right to avoid a contract ab initio for non-disclosure or misrepresentation should be abolished. The insurer should be entitled to cancel the contract prospectively. It should be entitled to damages for the breach of duty. This entitlement should be limited to a right to deduct from a claim an amount that fairly represents the loss it has suffered as a consequence of the insured’s breach of duty. Given the difficulties associated with proportionality and with the causal connection test, the only appropriate method for assessing this amount is in accordance with the principle applicable to the assessment of damages for fraudulent misrepresentation at common law. 195. Means of Evasion. One way in which an insurer might avoid the recommendations contained in the previous paragraph is by converting a misrepresentation or nondisclosure into a warranty of existing fact. For example, the contract might contain a term by which the insured warranted the truth of some, or all, of his answers in the proposal form. Under existing law, that would allow the insurer to terminate the contract and to sue for damages. Limitations on an insurer’s right to terminate contracts of insurance are recommended later in this report. However, warranties of existing fact are more akin to representations than they are to continuing warranties and similar terms in the contract. It would be undesirable in principle for the remedies for a breach to depend on the form in which the relevant obligation was phrased. Consequently, all warranties of existing fact should be treated as representations. 196. A Remedy for Fraud. Several members of the insurance industry have argued that, whatever changes may be made to the principles of non-disclosure and

misrepresentation, an insurer should always be entitled to avoid a contract ab initio in the event of fraud. This argument has been based on two main grounds. First, fraud on the part of the insured is so flagrant a breach of the duty of utmost good faith that avoidance of the contract is the only appropriate remedy. Secondly, if the penalty for fraudulent misrepresentation, like that for innocent misrepresentation, were to be limited to the loss actually caused by the insured’s conduct, there would be little disincentive to an insured against attempting to obtain lower premiums or more advantageous terms by misrepresenting facts clearly relevant to the insurer. On some occasions, the most an insured would lose would be the difference between the premium paid and the premium which ought to have been paid. This loss would normally be suffered, if at all, only upon a substantial claim being made under the contract. It might be worthwhile for an insured to gamble on the unlikelihood of a claim and on the likelihood of discovery by deliberately misrepresenting facts in order to obtain a reduced premium. Fraud certainly constitutes a serious breach of the duly of utmost good faith. But where that breach has not caused substantial harm, an attempt by the insurer to impose a much heavier loss on the insured would not necessarily demonstrate utmost good faith on its own part. Penalties are not normally imposed in other branches of the civil law. It is true that a party may avoid a contract for fraud, but, in areas other than insurance, that does not usually involve a penalty which far exceeds the ham caused by the fraud. Moreover, recent statutory restrictions on rights of avoidance themselves apply to both innocent and fraudulent misrepresentation. None the less, the disincentive argument is an important one. In some cases of course, a clear disincentive to fraud would exist. If the insurer would not have accepted the risk had it known the true facts, the insurer would he entitled to refuse a claim, notwithstanding the heavy loss thereby imposed. In

many other cases, however, a disincentive would be lacking. The insurer’s right to avoid a contract or a claim for fraudulent misrepresentation or non-disclosure should remain. The court should have power to disregard the avoidance and adjust the rights of the parties in cases where the loss of the insured’s claim would be seriously disproportionate to the harm which the insured’s conduct has or might have caused. In adjusting the rights of the parties, the court should be required to have regard to all relevant facts, including the need to deter fraudulent conduct by the insuring public.’

[432] (Australian) Insurance Contracts Act 1984 (as amended) Part IV—Disclosures and misrepresentations Division 1—The duty of disclosure 21 The insured’s duty of disclosure (1) Subject to this Act, an insured has a duty to disclose to the insurer, before the relevant contract of insurance is entered into, every matter that is known to the insured, being a matter that: (a) the insured knows to be a matter relevant to the decision of the insurer whether to accept the risk and, if so, on what terms; or (b) a reasonable person in the circumstances could be expected to know to be a matter so relevant. (2) The duty of disclosure does not require the disclosure of a matter: (a) that diminishes the risk; (b) that is of common knowledge; (c) that the insurer knows or in the ordinary course of the insurer’s business as an insurer ought to know;

or (d) as to which compliance with the duty of disclosure is waived by the insurer. (3) Where a person: (a) failed to answer; or (b) gave an obviously incomplete or irrelevant answer to; a question included in a proposal form about a matter, the insurer shall be deemed to have waived compliance with the duty of disclosure in relation to the matter. 21A Eligible contracts of insurance — disclosure of specified matters (added by the Insurance Law Amendment Act 1998) (1) This section applies to an eligible contract of insurance unless it is entered into by way of renewal.

Position of the insurer (2) The insurer is taken to have waived compliance with the duty of disclosure in relation to the contract unless the insurer complies with either subsection (3) or (4). (3) Before the contract is entered into, the insurer requests the insured to answer one or more specific questions that are relevant to the decision of the insurer whether to accept the risk and, if so, on what terms. (4) Before the contract is entered into, both: (a) the insurer requests the insured to answer one or more specific questions that are relevant to the decision of the insurer whether to accept the risk and, if so, on what terms; and (b) insurer expressly requests the insured to disclose each exceptional circumstance that: (i) is known to the insured; and (ii) the insured knows, or a reasonable person in the circumstances could be expected to know, is a matter relevant to the decision of the insurer

whether to accept the risk and, if so, on what terms; and (iii) is not a matter that the insurer could reasonably be expected to make the subject of a question under paragraph (a); and (iv) is not a matter covered by subsection 21(2). (5) If: (a) the insurer complies with subsection (3) or (4); and (b) the insurer asks the insured to disclose to the insurer any other matters that would be covered by the duty of disclosure in relation to the contract; the insurer is taken to have waived compliance with the duty of disclosure in relation to those matters.

Position of the insured (6) If: (a) the insurer complies with subsection (3); and (b) in answer to each question referred to in subsection (3), the insured discloses each matter that: (i) is known to the insured; and (ii) a reasonable person in the circumstances could be expected to have disclosed in answer to that question; the insured is taken to have complied with the duty of disclosure in relation to the contract. (7) If: (a) the insurer complies with subsection (4); and (b) in answer to each question referred to in paragraph (4)(a), the insured discloses each matter that: (i) is known to the insured; and (ii) a reasonable person in the circumstances could be expected to have disclosed in answer to that question; and (c) the insured complies with the request referred to in paragraph (4)(b); the insured is taken to have

complied with the duty of disclosure in relation to the contract.

Onus of proof — exceptional circumstance (8) In any proceedings relating to this section, the onus of proving that a matter is an exceptional circumstance covered by subparagraph (4)(b)(iii) lies on the insurer. Definition (9) In this section: eligible contract of insurance means a contract of insurance that is specified in the regulations. 22 Insurer to inform of duty of disclosure (1) The insurer shall, before a contract of insurance is entered into, clearly inform the insured in writing of the general nature and effect of the duty of disclosure and, if section 21A applies to the contract, also clearly inform the insured in writing of the general nature and effect of section 21A. (2) If the regulations prescribe a form of writing to be used for informing an insured of the matters referred to in subsection (1), the writing to be used may be in accordance with the form so prescribed. (2) An insurer who has not complied with subsection (1) may not exercise a right in respect of a failure to comply with the duty of disclosure unless that failure was fraudulent. Division 2 — Misrepresentations

23 Ambiguous questions Where:

(a) a statement is made in answer to a question asked in relation to a proposed contract of insurance or the provision of insurance cover in respect of a person who is seeking to become a member of a superannuation or retirement scheme; and (b) a reasonable person in the circumstances would have understood the question to have the meaning that the person answering the question apparently understood it to have; that meaning shall, in relation to the person who made the statement, be deemed to be the meaning of the question. …

25 Misrepresentation by life insured Where, during the negotiations for a contract of life insurance but before it was entered into, a misrepresentation was made to the insurer by a person who, under the contract, became the life insured or one of the life insureds, this Act has effect as though the misrepresentation had been so made by the insured.

26 Certain statements misrepresentations

not

(1) Where a statement that was made by a person in connection with a proposed contract of insurance was in fact untrue but was made on the basis of a belief that the person held, being a belief that a reasonable person in the circumstances would have held, the statement shall not be taken to be a misrepresentation. (2) A statement that was made by a person in connection with a proposed contract of insurance shall not be taken to be a misrepresentation unless the person who made

the statement knew, or a reasonable person in the circumstances could be expected to have known, that the statement would have been relevant to the decision of the insurer whether to accept the risk and, if so, on what terms… Division 3 — Remedies misrepresentation

for

non-disclosure

and

28 General insurance (1) This section applies where the person who became the insured under a contract of general insurance upon the contract being entered into: (a) failed to comply with the duty of disclosure; or (b) made a misrepresentation to the insurer before the contract was entered into; but does not apply where the insurer would have entered into the contract, for the same premium and on the same terms and conditions, even if the insured had not failed to comply with the duty of disclosure or had not made the misrepresentation before the contract was entered into. (2) If the failure was fraudulent or the misrepresentation was made fraudulently, the insurer may avoid the contract. (3) If the insurer is not entitled to avoid the contract or, being entitled to avoid the contract (whether under subsection (2) or otherwise) has not done so, the liability of the insurer in respect of a claim is reduced to the amount that would place the insurer in a position in which the insurer would have been if the failure had not occurred or the misrepresentation had not been made.

29 Life insurance

(1) This section applies where the person who became the insured under a contract of life insurance upon the contract being entered into: (a) failed to comply with the duty of disclosure; or (b) made a misrepresentation to the insurer before the contract was entered into; but does not apply where: (c) the insurer would have entered into the contract even if the insured had not failed to comply with the duty of disclosure or had not made the misrepresentation before the contract was entered into; or (d) the failure or misrepresentation was in respect of the date of birth of one or more of the life insureds. (2) If the failure was fraudulent or the misrepresentation was made fraudulently, the insurer may avoid the contract. (3) If the insurer would not have been prepared to enter into a contract of life insurance with the insured on any terms if the duty of disclosure had been complied with or the misrepresentation had not been made, the insurer may, within 3 years after the contract was entered into, avoid the contract. (4) If the insurer has not avoided the contract, whether under subsection (2) or (3) or otherwise, the insurer may, by notice in writing given to the insured before the expiration of 3 years after the contract was entered into, vary the contract by substituting for the sum insured (including any bonuses) a sum that is not less than the sum ascertained in accordance with the formula SP/Q where: S is the number of dollars that is equal to the sum insured (including any bonuses). P is the number of dollars that is equal to the premium that has, or to the sum of the premiums that have, become payable under the contract; and

Q is the number of dollars that is equal to the premium, or to the sum of the premiums, that the insurer would have been likely to have charged if the duty of disclosure had been complied with or the misrepresentation had not been made. (5) In the application of subsection (4) in relation to a contract that provides for periodic payments, the sum insured means each such payment (including any bonuses). (6) A variation of a contract under subsection (4) has effect from the time when the contract was entered into. 31 Court may disregard avoidance in certain circumstances (1) In any proceedings by the insured in respect of a contract of insurance that has been avoided on the ground of fraudulent failure to comply with the duty of disclosure or fraudulent misrepresentation, the court may, if it would be harsh and unfair not to do so, but subject to this section, disregard the avoidance and, if it does so, shall allow the insured to recover the whole, or such part as the court thinks just and equitable in the circumstances, of the amount that would have been payable if the contract had not been avoided. (2) The power conferred by subsection (1) may be exercised only where the court is of the opinion that, in respect of the loss that is the subject of the proceedings before the court, the insurer has not been prejudiced by the failure or misrepresentation or, if the insurer has been so prejudiced, the prejudice is minimal or insignificant. (3) In exercising the power conferred by subsection (1), the court: (a) shall have regard to the need to deter fraudulent conduct in relation to insurance; and (b) shall weigh the extent of the culpability of the insured in the fraudulent conduct against the

magnitude of the loss that would be suffered by the insured if the avoidance were not disregarded; but may also have regard to any other relevant matter. (4) The power conferred by subsection (1) applies only in relation to the loss that is the subject of the proceedings before the court, and any disregard by the court of the avoidance does not otherwise operate to reinstate the contract.

Notes: 1. See Tarr and Tarr, “The insured’s non-disclosure in the formation of insurance contracts: a comparative perspective” [2001] ICLQ 577. 2. It has been commented above that the rigour of the duty of disclosure has to some extent been mitigated by the self-regulatory response of the ABI to the various calls for reform. The Statements only apply to consumer-insureds and will not necessarily be followed by insurers who are not members of Lloyd’s or the Association of British Insurers. [433] Statements of General Insurance Practice (London, Association of British Insurers, 1986) (replacing 1977). ‘The following statement of normal insurance practice, issued by the Association of British Insurers, applies to general insurance of policyholders resident in the UK and insured in their private capacity only [emphasis added].

1. Proposal forms

…(c) If not included in the declaration [at the foot of the proposal form], prominently displayed, on the proposal form should be a statement: (i) drawing the attention of the proposer to the consequences of the failure to disclose all material facts, explained as those facts an insurer would regard as likely to influence the acceptance and assessment of the proposal. (ii) warning that if the proposer is in any doubt about facts considered material, he should disclose them. (d) Those matters which insurers have found generally to be material will be the subject of clear questions in proposal forms. (e) So far as is practicable, insurers will avoid asking questions which would require expert knowledge beyond that which the proposer could reasonably be expected to possess or obtain or which would require a value judgement on the part of the proposer. (f) Unless the prospectus or the proposal form contains full details of the standard cover offered, and whether or not it contains an outline of that cover, the proposal form shall include a prominent statement that a specimen copy of the policy form is available on request. (g) Proposal forms shall contain a prominent warning that the proposer should keep a record (including copies of letters) of all information supplied to the insurer for the purpose of entering into the contract. (h) The proposal form shall contain a prominent statement that a copy of the completed form: (i) is automatically provided for retention at the time of completion; or (ii) will be supplied as part of the insurer’s normal practice; or

(iii) will be supplied on request within a period of three months after its completion. (i) An insurer shall not raise an issue under the proposal form, unless the policyholder is provided with a copy of the completed form… (For ‘Claims’ (para 2) see chapter 11, below)

3. Renewals (a) Renewal notices shall contain a warning about the duty of disclosure including the necessary to advise changes affecting the policy which have occurred since the policy inception or last renewal date, whichever was the later. (b) Renewal notices shall contain a warning that the proposer should keep a record (including copies of letters) of all information supplied to the insurer for the purposes of renewal of the contract.

4. Commencement Any changes to insurance documents will be made as and when they need to be reprinted, but the Statement will apply in the meantime.

5. Policy Documents Insurers will continue to develop clearer and more explicit proposal forms and policy documents whilst bearing in mind the legal nature of insurance contracts.

6. Disputes The provision of the Statement shall be taken into account in arbitration and any other referral procedures which may

apply in the event of disputes between policyholders and insurers relating to matters dealt with in the Statement.

7. European Union This Statement will need reconsideration when the Draft EEC Directive on Insurance Contract Law is adopted and implemented in the United Kingdom. [This provision is now redundant].’

[434] Statements of Long Term Insurance Practice (London, Association of British Insurers, 1986). ‘This statement relates to long term insurance effected by individuals resident in the United Kingdom in a private capacity [emphasis added].

1. Proposal forms (a) If the proposal form calls for the disclosure of material facts a statement should be included in the declaration, or prominently displayed elsewhere on the form or in the document of which it forms part: (i) drawing attention to the consequences of failure to disclose all material facts and explaining that these are facts that an insurer would regard as likely to influence the assessment and acceptance of a proposal; (ii) warning that if the signatory is in any doubt about whether certain facts are material, these facts should be disclosed… (c) Those matters which insurers have commonly found to be material should be the subject of clear questions in

proposal forms. (d) Insurers should avoid asking questions which would require knowledge beyond that which the signatory could reasonably be expected to possess. (e) The proposal form or a supporting document should include a statement that a copy of the policy form or of the policy conditions is available on request. (f) The proposal form or a supporting document should include a statement that a copy of the completed proposal form is available on request.

2. Policies documents

and

accompanying

(a) Insurers will continue to develop clearer and more explicit proposal forms and policy documents whilst bearing in mind the legal nature of insurance contracts. (b) Life assurance policies or accompanying documents should indicate: (i) the circumstances in which interest would accrue after the assurance has matured; and (ii) whether or not there are rights to surrender values in the contract and, if so, what those rights are. (Note: The appropriate sales literature should endeavour to impress on proposers that a whole life or endowment assurance is intended to be a long term contract and that surrender values, especially in the early years, are frequently less than the total premiums paid.)… (For ‘Claims’ (para 3) see chapter 11, below).

4. Disputes The provisions of the Statement shall be taken into account in arbitration and any other referral procedures which may

apply in the event of disputes between policyholders and insurers relating to matters dealt with in the Statement.

5. Commencement Any changes to insurance documents will be made as and when they need to be reprinted, but the Statement will apply in the meantime. Note regarding industrial assurance policyholders. Policies effected by industrial assurance policyholders are included amongst the policies to which the above Statement of Long Term Insurance Practice applies. Those policyholders also enjoy the additional protection conferred upon them by the Industrial Assurance Acts 1923 to 1969 and Regulations issued thereunder. These Acts give the Industrial Assurance Commissioner wide powers to cover inter alia the following aspects: (a) Completion of proposal forms. (b) Issue and maintenance of premium receipt books. (c) Notification in premium receipt books of certain statutory rights of a policyholder including rights to: (i) an arrears notice before forfeiture; (ii) free policies and surrender values for certain categories of policies; (iii) relief from forfeiture of benefit under a policy on health grounds unless the proposer has made an untrue statement of knowledge and belief as to the assured’s health; (iv) reference to the Commissioner as arbitrator in disputes between the policyholder and the company or society The offices transacting industrial assurance business have further agreed that any premium (or deposit) paid on completion of the proposal form will be returned to the

proposer if, on issue, the policy document is rejected by him or her.’

[435] A Forte “The revised Statements of Insurance Practice: cosmetic change or major surgery?” [1986] MLR 754 ‘CONCLUSION The revised Statements represent a genuine attempt by the insurance industry to meet some of the criticisms levelled against it and it would be unduly cynical to describe them as mere tokenism. Nonetheless, by adhering closely to the Law Commission’s proposals, on which any legislation would have been modelled, the Statements represent a minimalist attitude to the problem of abuses. They do not, for example, address themselves to the question of risk exclusion by means of “excepted perils” clauses…The Law Commission did not recommend legislative control of clauses descriptive of risk [see chapter 8, below] though they recognised that their use might be one way of avoiding their proposals for reforming warranties. Nor did the Commission tackle the problem of average clauses which enable insurers to penalise a claimant for under-insurance… …Although the Statements can be criticised, this does not mean that it is enough, or even sometimes fair, to confine one’s criticisms to them. The Law Commission, for example, refused to countenance a separate regime for consumers, though the Statements have in fact created one. There has, rather, been a failure to resolve some of the more fundamental issues which flow from the existence of such codes. Why, for example, can there not now be a simple legislative change of the law abolishing the duty of disclosure? The spirit of the Statements is certainly inimical to its continued existence. And why should these particular codes be a substitute for legislation rather than, as in many

other cases, a supplement to it? If insurers are prepared, under threat of legislation, to construct a regime which would substantially replicate, in unenforceable codes of practice, the broad proposals which might have been enacted, then why are they so concerned to avoid statutory regulation? The question is all the more intriguing when one considers the participation by British insurance companies in the United States where there is far greater legislative control over the use warranties and the notion of uberrima fides has all but disappeared. For the immediate future, consumers must rest content with the voluntary adherence of insurers to the Statements. And it must be regarded as being fundamentally unsatisfactory that the consumer of insurance services continues to receive less favourable treatment than the consumer of goods and other services…In the long term, administrative control of insurance contracts will probably occur as it does elsewhere. The Statements are a last attempt to stop this. Their success in so doing should only be a temporary one.’

Note: Notwithstanding the insurance industry’s attempts to stave off the various calls for reform by the simple expedient of self-regulation, the National Consumer Council has nevertheless called for legislative intervention along the lines seen in Australia with the objective of constructing a wide ranging scheme of effective consumer protection is to be achieved. [436] Insurance Law Reform — The consumer case for a review of insurance law (London, NCC 1997)

‘4.3 Non-disclosure and misrepresentation The consumer’s absolute legal duty in connection with nondisclosure and misrepresentation — and particularly the insurer’s remedy of avoidance of the contract — is widely agreed to be unfair and unclear to consumers. The practices adopted by the industry’s Insurance Ombudsman have changed the position somewhat from what it was when the Law Commission made its recommendations for reform in the early 1980s — outlined above in section 2.2. The Ombudsman already goes further than those recommendations. His terms of reference allow him to take account of statements and codes of practice in reaching a decision and he can offer different remedies for nondisclosure and misrepresentation than avoidance of the whole contract. If anything, however, this development reinforces the need for reform of the law. As we have seen, the industry’s code and statements carry no legal force and so do not apply to the minority of insurers that do not belong to the Association of British Insurers or the Insurance Ombudsman scheme. Consumers who choose to take a dispute to their local county court and those who cannot use the Ombudsman scheme because their insurer is not a member do not even have this minimal protection. If the statements of practice had statutory force, perhaps as a requirement of authorisation, more consumers would be more effectively protected. (If an insurer carries on insurance business in the UK it must, under the Insurance Companies Act 1982, be authorised or permitted to do so by the Department of Trade and Industry. The exact meaning of carrying on insurance business in the UK is not defined in the legislation — each case has to be considered individually. Although it is an offence to carry on insurance business in the UK without authorisation or permission, it is legal to sell insurance that is carried on “off shore”.)

Again, Australia provides a useful comparative model. The test in Australia of what an insurer must be told and the consequences of a failure to tell are fairer to the consumer. We draw on the Australian legislation as a basis for our own proposals for the UK. However…Australian experience is that extra care is necessary to protect innocent co-insureds and people from non-English speaking backgrounds. Telephone selling, a growth area for insurance in the UK too, can also cause disputes over the level of understanding of disclosure. If the duty is not to be abolished the burden of proving an appropriate explanation has been given should be borne by the insurer.

Recommendation 4 We recommend reform of the law on insurance to require insurers to give notice to the buyer, in writing, of the general nature and effect of the duty of disclosure. In the event of failure to do this, the burden of proof being on the insurer, the insurer should not be able to rely upon any defence except fraudulent concealment by the policy holder. Recommendation 5 The insured person’s duty on disclosure and misrepresentation should be defined in law as follows: (a) The insured consumer has a duty to disclose facts within his or her knowledge which either he/she knows to be relevant to the insurer’s decision or which a reasonable person in the circumstances could be expected to know to be relevant. (b) An untrue statement made by an insured person is not misrepresentation if he/she honestly believed it to be true, and is a misrepresentation in law only if the insured person knew, or a reasonable person in his position could be expected to have known, that the statement would have been relevant to the insurer’s decision.

(c) If there has been a relevant non-disclosure or misrepresentation, the insurer has no remedy if its decision would not in fact have been any different. (d) If a misrepresentation or non-disclosure is nonfraudulent, the insurer retains liability under the policy but is entitled to deduct the extra premium it would have charged had there been no non-disclosure or misrepresentation. The contract can be avoided only where there is fraudulent non-disclosure or misrepresentation or it would not have insured the risk. 4.4 Utmost good faith The fact that, in UK law, the contract of insurance is a contract requiring the insurer as well as the insured to display the utmost good faith has practically no useful consequences for consumers. As we saw [above], it does not help the policyholder whose insurer is unconscionably slow in paying a claim nor the policy holder who has been misled about the content of the policy. The provisions in sections 13 and 14 of the Australian Insurance Contracts Act reflect the law as it is in the UK — but they go further, emphasising by statute that good faith is an obligation of both parties. The same sort of clarification of the UK law would immeasurably strengthen the hands of consumers with legitimate grievances, in particular about the mis-selling of policies.

Recommendation 6 We recommend legal codification of the principle of utmost good faith in insurance contracts, by defining it as follows: (a) an insurance contract is a contract based on the utmost good faith, where it is implied that each party should act towards the other party, in respect of any matter arising under or in relation to it, with the utmost good

(b) the duty includes the requirement that an insurer who unreasonably in paying a claim is liable for breach of contract; (c) the duty includes the requirement that the insurer bring to the insured consumer’s attention the general nature and effect of his/her obligations under the contract; failure to do so will mean the insurer cannot rely upon a breach by the insured; (d) remedies for breach of the duty (other than those covered by (c) above) would include damages. [437] Sir Andrew Longmore (Lord Justice of Appeal), “An Insurance Contracts Act for a new century?” [2001] Lloyd’s Maritime and Commercial Law Quarterly 356. ‘…There are numerous areas where reform would be useful and some where it is essential. Piecemeal proposals for reform have not worked well in the past; reform elsewhere in the world is made more difficult by the fact that the City of London remains the leading insurance centre of the world. Other countries are somewhat reluctant to adopt reforms if the risk is likely to be reinsured by a significantly different law. The time has come when, in my view, both the law and the market should adopt sensible reform across the board. There has been some reform in the area of what I may call insurance by consumers as a result of the Unfair Terms in Consumer Contracts Regulations 1994/924 but it does not extend to business insurance or to the general law of avoidance for non-disclosure or misrepresentation; proposals for reform of business insurance have fought shy of reforming marine and aviation insurance as well…. Codification or Piecemeal Reform? There is an argument for codification of insurance law in general just as Chalmers codified the law of marine

insurance in 1906. I would have no principled objection to such a proposal but it would be an enormous task and invite yet further delay. In this context. Sir Mackenzie Chalmers’ own thoughts are worth reading. The Marine Insurance Bill was first introduced to Parliament in the early 1890s. It took 12 years to reach the statute book. He published the originally proposed Bill as a Digest of the law relating to marine insurance. In 1901 he said this: “The future which awaits the Bill is uncertain. Mercantile opinion is in favour of codification. but probably the balance of legal opinion is against it. As long as freedom of contract is preserved, it suits the man of business to have the law stated in black and white. The certainty of the rule laid down is of more importance than its nicety. It is cheaper to legislate than to litigate; moreover, while a moot point is being litigated and appealed, pending business is embarrassed. The lawyer, on the other hand, feels cramped by codification…No code can provide for every case that may arise, or always use language which is absolutely accurate. The cases which come before lawyers are the cases in which the code is defective. In so far as it works well it does not come before them. Every man’s view of a question is naturally coloured by his own experience. and a lawyer’s view of commerce is perhaps affected by the fact that he sees mainly the pathology of business. He does not often see its healthy physiological action.” I would prefer the Law Commission to consider what reform is really necessary an attempt to re-engage Government to enact those reforms. I suggest 6 topics in particular: (1) whether a doctrine of the utmost good faith should be retained and, if so what its content should be; (2) the appropriate test for an insurer or reinsurer who wishes to defend a claim on the basis of non-

disclosure and misrepresentation before formation of the contract; (3) the remedies which should be open to an insurer or reinsurer if he wishes to defend a claim on the ground of non-disclosure or misrepresentation; (4) the right approach to breach of warranty by the insured; (5) the right approach to proposal forms and answers given being declared to be the basis of the contract; (6) the question whether damages should be payable for insurers’ refusal to pay a valid claim. I have said enough already on the first topic of the utmost good faith. But I would like to say something more about the appropriate test for evidence of non-disclosure and misrepresentation.

Test for avoidance The current law in relation to the objective part of the test is settled by Pan Atlantic v Pine Top and I hope I summarise it correctly by saying it is whether the non-disclosed or misrepresented fact would have been taken into account by a prudent insurer when assessing the risk. My own view is that, even after the addition of the subjective part of the test (actual inducement), this tilts the matter too heavily in the insurers’ favour. Mr David Higgins of Herbert Smith has observed that it does not reflect the way in which insurance business is actually underwritten to suppose that an insurer just sits silently while a presentation is made to him and then, without speaking a word, signs a slip or other contractual document. As Staughton LJ said recently (Kausar v Eagle Star): “Avoidance for non-disclosure is a drastic remedy. It enables the insurer to disclaim liability after, and not before, he has discovered that the risk turns out to be a bad one; it leaves the insured without the protection which he thought he had

contracted and paid for…I do consider there should be some restraint in the operation of the doctrine. Avoidance for honest non-disclosure should be confined to plain cases.” Any rational discussion of this thorny topic needs to take into account alternative formulations. Six possible alternative formulations spring to mind and, no doubt, others can be considered. 1) Whether a prudent insurer would have considered that, if the relevant matter had been disclosed, the risk was a different risk; this is the formulation preferred by the Court of Appeal in St Paul Fire and Marine v McConnell; they obviously did not consider it any different from the Pan Atlantic test; but I do wonder; a prudent insurer may take something into account without it being a factor that would make the risk different in any sensible use of the word “different”; 2) whether, if the matter had been disclosed, the prudent insurer would have declined the risk or written it in different terms (the decisive influence test which was espoused by the minority but rejected by the majority in Pan Atlantic v Pine Top); 3) whether a reasonable insured would have considered the undisclosed matter to be material to a prudent insurer. (This is the solution adopted by statute in Australia and was recommended here by our own Law Commission); 4) whether the actual insured ought to have considered the undisclosed matter to be material to a prudent insurer; 5) whether the undisclosed matter was a matter which a reasonable insured would realise was within the knowledge only of himself (or those for whom he is responsible) rather than a matter which could have been independently investigated and verified by insurers; 6) whether the duty on an insured should be merely to answer correctly any question asked by the insurer; this

would be to abandon any requirement of disclosure at all. While I would not favour the total abolition of the requirement of disclosure, my own view for what that is worth is that option 5 has much to commend it, viz that the insured should only be expected to disclose what a reasonable insured in his position should have appreciated was material and within his own knowledge rather than a matter which could have been independently verified. This seems to have been the law in the aftermath of Lord Mansfield’s famous decision in Carter v Boehm in which, it is sometimes forgotten, the insured actually succeeded. In 1817. it was expressly held in Friere v Woodhouse: “What is exclusively known to the assured ought to be communicated; but what the underwriter, by fair inquiry and due diligence may learn from ordinary sources of information need not be disclosed.” Of course, ordinary sources of information are far more extensive now that in the early nineteenth century but that seems to me to make stronger rather than weaker the case for a professional underwriter having to equip himself with knowledge of matters that can be independently investigated and verified.

Remedies I have already remarked that one of the difficulties about a doctrine of avoidance for nondisclosure and representation in insurance law is that it is such an extreme remedy. That was a major reason why the House of Lords in The Star Sea declined to extend the doctrine of good faith in its widest form to post-contract dealings. The remedy would be worse than the disease.

The remedy may, however, be equally extreme in relation to pre-contract non-disclosure and misrepresentation. This was, of course, considered by the Law Commission in their 1980 report. They rejected, for good reasons as it seems to me, the notion of proportionality as espoused in some European countries and in the then proposed European Directive. But I feel they may have rejected too readily the idea that the court should be vested with a discretion in a suitable case to adjust the parties’ respective responsibilities. It is a concept that appealed to at least one member of the Court of Appeal when it decided Pan Atlantic. It would not be so necessary, no doubt, if there were to be reform of the law to adopt the reasonable insured test since, if an insured cannot recover on that test, he would only have himself to blame; it may well be for this reason that the Law Commission did not consider the proposal in any substantial detail. But if the tests for disclosure and misrepresentation are to remain as they are, a discretionary apportionment of the loss has much to recommend it. It would, of course, lead to some uncertainty but that, after all, was a reason against the introduction of the concept of contributory negligence which, in the event, is a concept that has worn the test of time very well. In these days when the incidence of costs in litigation may depend on well or illinformed guesses made by the litigant, at the time they are obliged to serve pre-action protocols, uncertainty is endemic, yet the court, and litigants, are quite good at getting used to it. Moreover, the Insurance Ombudsman Bureau apparently uses its discretion on occasion to apportion the loss and appears to have no difficulty with the concept. I do not think I need say anything in particular about the 4th and 5th topics on my list; breach of warranty and basis of the contract clauses. The evils of the present law are, I think, well enough known and universally acknowledged and

it is about time that the law was changed to accord with an ordinary person’s expectations. Mind you, the doctrine of warranty sometimes works against insurers. I expect that most of you know of the recent case about the man from North Carolina who insured a box of two dozen expensive cigars against, among other risks, fire; having smoked the entire stock and without even having paid the premium for the policy, he sued the insurers on the basis that the cigars had been lost “in a series of small fires”; the company refused to pay but the judge held the company liable on the basis that it had warranted that the cigars were insurable and had not stipulated what they considered to be an unacceptable fire. So the company had to pay the claim amounting to $15,000. However the story has a happy ending because once the insured had cashed the cheque, the insurance company had him arrested on 24 charges of arson and the insured was convicted of intentionally burning the insured property, which resulted in 24 months in jail and a fine of $24,000. The question of delay in paying valid claims is a newer topic, which, it seems to me, does merit consideration. The courts have set their face against there being an implied term of an insurance contract that valid claims will be met and thus do not award damages against an insurer even if his delay in negotiating the claim means that the insured goes out of business. In a sense this is part of a wider point viz whether interest is truly compensation for delayed payment of claims for damages. But it has always been an oddity that a claim under an insurance policy is treated by the law as a claim for damages rather than a straight debt. This is a doctrine that could be usefully considered, I suggest, by the Law Commission. Where Do We Go From Here? In terms of legal principle and abstract justice, the case for reform in the areas about which I have been talking is

extremely strong. Opposition to reform may come from the insurers’ side of the insurance industry who like to rely on the content of the present law and, perhaps, from Government on the grounds of inertia rather than principle. Siren voices will say “Show us the law is working unjustly in practice before we take any interest in proposals for reform.” On the assumption that. unlike Odysseus’s crew, we should not consent to have our ears stopped with sealing wax, there are perhaps two separate ways to deal with these siren voices. The first is to do some empirical research in order to discover whether insureds have suffered injustice in the areas I have been considering. In this respect the records of the Ombudsman Bureau will be an early port of call. The experience of other Law Commissions, eg., in Australia and Canada can be investigated. London firms of insurance brokers and of solicitors will be able to help, but it may be even more important to consult out of London brokers and solicitors. Barristers will be much less help because for every insured whom counsel has, regretfully or otherwise, to advise that he is likely to lose, there will be many insureds who have already given up the struggle in correspondence, well before there is any question of obtaining counsel’s opinion. The judiciary are even less well placed to give examples of injustice since no insured will want to fight a case he knows he will probably lose. Despite the difficulties, I would urge the Law Commission to undertake a research project. I doubt if they would find that there is any widespread devotion to the present state of the law. But secondly there is the question of principle. How can it be right that a lawyer insuring his home and household possessions can rely on a more relaxed test of nondisclosure under the Statements of Practice, but the small trader, eg. the garage owner or the fishmonger insuring his premises, cannot. The truth is that the same standard

should apply to both and it should, at least, be the standard of the reasonable insured. The very fact that insurance companies are so anxious to persuade people that the best form of self-regulation is to ensure that the law is not enforced in its full rigour shows that insurers are worried that, if the law if reformed, they would have to pay more claims. If they accept that for the consumer, why should the law not be the same for the small business as indeed a wealthy business? The very acceptance by the insurance industry of the Statements of Practice shows that the law ought to be different from what it is. If even insurers accept that, surely it is time that the rights of not merely consumers but of all insured persons should be enforceable as a matter of right, not as a matter of discretion. Surely we should be able to look forward to a better day…’

[438] Report of the Sub-Committee of the British Insurance Law Association, Insurance Contract Law Reform (London, Centre for Financial Regulation Studies London Guildhall University, 2002) ‘INSURANCE CONTRACT LAW REFORM A Report of the BILA Sub-Committee

Formation 1. This Sub-Committee was formed in January 2001 to examine areas of insurance law causing concern in the insurance market and in insurance disputes, and to make recommendations to the Law Commission as to the desirability of drafting a new Insurance

Contracts Act in respect of Marine and Non-Marine Insurance and/or other reforms to current legislation… 3. Our over-riding objective has been to put forward ideas for consideration by the Law Commission, in the context of the wider perspective the Commission is able to form from its consultations with interested parties. 4. We are satisfied that there is a need for reform. This is supported by the excellent report of the National Consumer Council in 1997. We believe that it is important to start by the speedy implementation of the recommendations of the 1980 Law Commission, which we believe to be non-controversial. We hope that it can be updated by some revisions along the lines we suggest… 9. This [Law Commission] report has been widely praised, but its implementation has not been forthcoming…We respectfully adopt what is said in [Longmore LJ’s]… lecture [see above, [437]]…Longmore LJ summarises the history of inactivity, and concludes “…this is not just good enough.” We agree… 10. This Sub-Committee’s view is that the starting point for reform should be the implementation of this Report, and the enactment of the draft Bill, with only such alterations as are sufficiently non-controversial as not to delay this enactment. 11. We agree wholeheartedly with the Commission that Statements of Practice, particularly limited to those insuring in their private capacity, are not sufficient to protect insureds. Nor do we think that the fact that the Ombudsman is bound to act in accordance with what is fair and reasonable and therefore does not always apply the strict letter of the law, removes the need for law reform. Many disputes are not settled by that route. The appropriate course is to remove

unfairnesses in the law, not simply to alleviate the unfairnesses… Possible Alterations To The Draft Bill 17. Longmore LJ in his [article, above, [437]], suggests 6 topics for the Law Commission to consider. We take each in turn on the basis that the reforms are limited to the types of insurance covered by the draft Bill [extracted in chapter 8 below]: 17.1 “1. Whether a doctrine of utmost good faith should be retained and if so, what its content should be.” We think that the answer should be yes, but with modifications, which we shall discuss in paras 19–23 below. Utmost good faith should apply to the whole period of the contract. The nature of the duty will vary with the phase and circumstances of the relationship: The Star Sea [see above, [425]], per Lord Clyde and per Lord Hobhouse. 17.2 “2. The appropriate test for an insurer or reinsurer who wishes to defend a claim on the basis of nondisclosure and misrepresentation before formation of the contract.” The House of Lords in Pan Atlantic v Pine Top decided (i) that the test of materiality was the objective one of whether the non-disclosed (or misrepresented) matter would have been taken into account by a prudent insurer when assessing the risk and (ii) by a new departure, that subjectively, the actual insurer had to prove that he was induced to enter into the contract on the relevant terms by the non-disclosure (or misrepresentation). Longmore LJ mentions six possible formulations for reform…We prefer his third alternative (“whether a reasonable insured would have considered the undisclosed matter to be material to a prudent insurer”), which is the solution recommended by the Law Commission and included in the draft Bill. It has also been adopted in Australia by the Insurance Contracts Act 1984, and is the proposed solution

in the Australian Law Reform Commission (‘ALRC’) report reviewing the Marine Insurance Act 1909. We observe and agree with the views of Carnwath J (as he was then) sitting in the Court of Appeal in The Mercandian Continent [see chapter 11] that this “…report would be a very useful starting point for any consideration of law reform in this country.” 17.3 “3. The remedies which would be open to an insurer or reinsurer if he wishes to defend a claim on the grounds of non-disclosure or misrepresentation.” 17.3.1 The sole remedy currently available for nondisclosure or misrepresentation is the draconian remedy of avoidance of the contract of insurance, whether the misrepresentation or non-disclosure was fraudulent, negligent or innocent. This position has been the subject of sustained criticism from the courts (eg in Pan Atlantic v Pine Top supra) and from academic lawyers. We consider that reforms are necessary for the protection of the insured. 17.3.2 In the first place we would retain the right to avoid where there has been fraudulent or reckless misrepresentation or non-disclosure. We would equate blind eye recklessness (not caring whether a representation is true or false) with fraud. 17.3.3 More difficult are the remedies which should be available for innocent or negligent misrepresentation or non-disclosure. We believe that principles of proportionality should be introduced if possible, despite the 1980 Law Commission’s reluctance. 17.3.4 We would recommend a solution on the lines of Recommendation 25 of the ALRC: “Recommendation 25. The MIA should be amended to insert new provisions which provide that if the insured has breached its duties relating to non-disclosure and misrepresentation

(1) if the breach is fraudulent, the insurer is entitled to avoid the policy from its outset with no return of premium. (2) if the breach is not fraudulent: (a) where the insurer would not have entered into the contract if it had known of the undisclosed circumstances or the truth of the misrepresented circumstances, the insurer is entitled to avoid the policy from its outset but with a return of premium. (b) where the insurer would have entered into the contract but on other conditions, the insurer is not entitled to avoid the policy but: (i) is not liable to indemnify the insured for a loss proximately caused by the undisclosed or misrepresented circumstance; (ii) is entitled to vary its liability to the insured to reflect the amount of any variation in premium, deductible or excess that would have been imposed if it had known of the undisclosed circumstance or the truth of the undisclosed circumstance; [and (iii) is entitled to cancel the policy in accordance with the other provisions of the MIA on cancellation which are the subject of recommendation 18.1 (Recommendation 18 outlines other rights of cancellation. Clause 11 of the draft Bill adequately covers the position. Accordingly we do not consider that sub-sub recommendation 25(2)(b)(iii) need be included.) 17.4 “4. The right approach to breach of warranty by the insured” The draft Bill covers this in Clauses 8–12 inclusive. 17.5 “5. The right approach to proposal forms and answers given being declared to be the basis of the contract”

We agree with the views of the 1980 Law Commission, which would be implemented in Clause 9(1)(b) of the draft Bill. 17.6 “6. The question whether damages should be payable for insurers’ refusal to pay a valid claim.” 17.6.1 We agree with Longmore LJ that this is a topic to be considered by the Law Commission. Very often the speedy payment of an insurance claim is critical to an insured. Express terms may alleviate the situation, such as terms in householders’ policies to pay for alternative accommodation during rebuilding. But insureds may be driven into bankruptcy by delay, whether they insure in a business or a private capacity. 17.6.2 The situation could be improved by provisions along the following lines: (1) That a claim under an insurance contract is to be treated as a debt, and it is an implied term of the contract that the debt will be paid within a reasonable time, having regard to all the circumstances; (2) That it should be an implied term of an insurance contract that each party shall act towards the other party with utmost good faith. (3) That there shall be no right of avoidance in respect of a post-contractual failure to act with utmost good faith, except where the breach is materially fraudulent. 17.6.3 An alternative to treating the claim as a debt, would be to have a provision that breach of that duty gives rise to damages covering types of loss that an insurer should have had within reasonable contemplation. 18. We recommend that the following co-insurers should be deemed to be induced by misrepresentation or non-disclosure, if all the leading insurers were so

induced: see Recommendation 27 of the ALRC report and draft Section 26D of the proposed amendments. 19. The law on post-contract duty of utmost good faith has been the subject of 3 important decisions: The Star Sea and the Mercandian Continent and Agapitos v Agnew [see chapter 11, below]. The duty of utmost good faith applies after the conclusion of the contract. Lord Clyde in The Star Sea says that the contrary is “past praying for”, Lord Clyde goes on to point out that: “…the idea of good faith in the context of insurance contracts reflects the degree of openness required of the parties in the various stages of their relationship. It is not an absolute. The substance of the obligation which is entailed can vary according to the context in which the matter comes to be judged. It is reasonable to expect a very high degree of openness at the stage of the formation of the contract, but there is no justification for requiring that degree necessarily to continue once the contract has been made.” Post-contract the duty in respect of claims is a duty of honesty — ie not to be fraudulent. The duty of utmost good faith raises a strict duty of disclosure in respect of variations and renewals. It is potentially applicable in respect of a material change in risk, but it is important that the contract of insurance should include a specific condition for notification of material change of risk. 20. These cases underline the problem caused by the much criticised law that says avoidance is the only remedy for a failure to act with utmost good faith. That can never be of assistance to an insured treated by his insurer without utmost good faith. He wants his claim to be satisfied by payment or an award of damages — not the cover avoided.

21. The difficulties and problems caused are usefully set out in the ARLC Report at pp 222–32. We refer particularly to the observations of Lord Hobhouse in The Star Sea, cited in the ALRC Report at pp 224–5. He points to the appropriate remedy when he says: “[Post-contractual duties of good faith]…can derive from express or implied terms of the contract; it would be a contractual obligation arising from the contract and the remedies are the contract remedies provided by the law of contract. This is no doubt why judges have on a number of occasions been led to attribute the post-contract application of the principle of good faith to an implied term.” 22. The remedy lies in what we have already recommended in para. 17.6.2(2) and (3) above, namely that there should be an implied term that each party shall act towards the other party with utmost good faith. The remedy for breach would be damages to compensate the wronged party for his actual proved loss, according to ordinary principles of damages. Avoidance will only be available in respect of a materially fraudulent breach. 23. As to what constitutes the duty of utmost good faith in the post-contract situation, we see no reason why there should be statutory interference with the law as it is developing, most recently in The Star Sea, the Mercandian Continent and Agapitos v Agnew. If the breach is a materially fraudulent breach of the implied term in the sense that the fraud would have an effect on the underwriters’ ultimate liability, and the gravity of the fraud or its consequences were sufficient, this would enable the underwriters if they wished to do so, to terminate for breach of contract. It is desirable that insurance law should develop along the lines of general contract law…’

Notes: 1. Many USA jurisdictions have confined the strict duty of disclosure to marine policies so that for other branches of insurance, such as life and fire, proof of intent to conceal is a prerequisite to the insurer avoiding the policy: Holtzclaw v Bankers Mutual Insurance Co 448 NE 2d 55(Ind App 3d Dist, 1983). Further, some state statutes restrict an insurer’s right to avoid a policy for non-disclosure or misrepresentation by requiring proof of intentional concealment or misrepresentation of a material fact. Other states, such as Alabama, are more insurerfriendly by permitting avoidance where the non-disclosure/misrepresentation was such as to increase the risk of loss (see Bankers Life and Casualty Co v Long, below, [439]). 2. The majority of states follow the English approach towards the determination of materiality. In Nappier v Allstate Insurance Co 961 F.2d 168, 170 (1992) the court stated that: “A material [fact] is one that would influence a prudent insurer in deciding whether to assume the risk of providing coverage.” [439] Bankers Life & Casualty Co v Long Court of Civil Appeals of Alabama 48 Ala App 570, 266 So 2d 780 (1972) [The facts appear from the judgment]. Holmes J:

‘This is an appeal from a verdict and judgment rendered thereon in a suit on a life insurance policy issued by appellant insurance company. The policy sued on was issued to William B Long on 1 April 1968, in the amount of $10,000. Appellee, the widow of William B Long, the beneficiary of the policy, filed a claim for the proceeds of the policy. This claim was denied by appellant insurance company and, thereafter, appellee filed suit. The insurance company plead the general issue in short by consent. The case was tried before a jury and judgment was rendered in favour of the beneficiary, the appellee here, for the amount of the policy. Appellant, in his appeal, brings some four assignments of error. Both appellant and appellee agree that the issue presented is whether the policy sued on was void because of misrepresentations made by the policy holder William B. Long, which increased the risk of loss to appellant or which were made with actual intent to deceive. Tit. 28, § 6, Code of Alabama 1940, provides that: “No written or oral misrepresentation, or warranty therein made, in the negotiation of a contract or policy of insurance, or in the application therefor or proof of loss thereunder, shall defeat or void the policy, or prevent its attaching, unless such misrepresentation is made with actual intent to deceive, or unless the matter misrepresented increase the risk of loss.” The policy was issued to the decedent, William B Long, upon a written application. The application was sent from appellant by a general mailing to all American Express credit card holders, of which decedent was one. The application was executed by decedent, insured, and by the

terms of the policy the application and the policy constituted the contract of insurance. The following are questions and answers in the application for insurance, pertinent to our review: “2. Has this person been hospitalized or had any medical or surgical treatment or checkups in the past 5 years? YES If answer is “yes” give full details below SICKNESS OR DEFECT DATE DURATION OPERATION Hepatitis 1-12-66 6 mos. None Doctor’s name and address Dr. Arthur M. Freeman c/o Medical Arts Bldg, Birmingham, Ala 3. “is this person in good health and free from any physical or mental impairment or disease?” YES (emphasis supplied)”. The medical record of decedent, as revealed by the record, shows the following medical history up to the time the written application for insurance was made with appellant, said application having been made on 7 March 1968: January 12 through February 21, 1966 — admitted to East End Memorial Hospital — admitting diagnosis was sclerosis liver, pencilled over which was “cirrhosis.” Final diagnosis was cirrhosis, alcoholic [Laennec’s] hepatitis, alcoholic. May 12 to June 20, 1966 — East End Memorial Hospital — diagnosis was sclerosis and hepatitis. Final diagnosis was “cirrhosis alcoholic; hepatitis sec to above.” Clinical findings on May 11, 1966, indicated “sclerosis and hepatitis.” July 20 to August 16, 1966 — admitted to Hill Crest Hospital. Admitting diagnosis and final diagnosis was cirrhosis of the liver. September 20 to October 13, 1967 — East End Memorial Hospital; diagnosis “lacerated scalp, poss head injury” and

final diagnosis was “laceration of left forehead, scalp, sec. to fail — cirrhosis.” The appellee testified she was the wife of William B. Long who died on 27 September 1969; that her husband was hospitalised in January 1969 and that Dr Doggett was the attending physician; that her husband was hospitalised in May 1966 and, later, in Hill Crest Sanitarium; that he took medication for his liver. Dr Doggett’s uncontradicted testimony was that cirrhosis of the liver would tend to shorten a person’s normal life expectancy; that he treated the deceased in the hospital in January 1966; that his admitting diagnosis was cirrhosis and the final diagnosis was cirrhosis of the liver — alcoholic cirrhosis; that there are different kinds of hepatitis and various degrees of hepatitis; further, that hepatitis could lead to cirrhosis and that alcoholic hepatitis would be a form of cirrhosis; that in his opinion assured had cirrhosis of the liver from January 1966 until his death. Dr Doggett further testified that the terms “hepatitis” by itself and “cirrhosis of the liver” are used interchangeably and that he could have used the term “hepatitis” with a patient rather than “cirrhosis.” The death certificate introduced into evidence without objection shows that the immediate cause of death was “cirrhosis liver.” James Day, the manager of the Life Underwriting Department of appellant, testified that in his opinion if the information concerning deceased’s hospitalisation in 1966 and 1967 and a diagnosis of cirrhosis of the liver had been listed the appellant would not have issued the policy as applied for. As we noted earlier, appellant’s plea was in short by consent and his motion for a new trial and this appeal is based on the theories that assured had cirrhosis of the liver at the time he executed the application for insurance, and in such application made misrepresentations with actual intent

to deceive, or misrepresented matters which increased the risk of loss. Of course, either alternative would justify avoidance of the policy by the insurance company. Liberty National Life Ins Co v Hale, 285 Ala. 198, 230 So. 2d 526. In other words, as the Supreme Court of Alabama has stated, to defeat the insurance policy for the reason of misrepresentation, it must appear that (1) the misrepresentations were false, (2) made either with actual intent to deceive or the matter misrepresented increased the risk of loss and (3) the insurer relied on them to its prejudice… The supreme court in the Hale case. above, quoted from New York Life Ins Co v Horton, 235 Ala. 626. 632, 180 So. 277, 282, as follows: “A candid and truthful answer would have enabled the insurer to discover the true facts with reference to the insured’s health. Insurance companies are entitled to candid and truthful answers, and when such candor is withheld and involves matters material to the risk, no just complaint can be raised, when, if after investigation, the falsity is discovered and the policies issued in reliance upon the truthfulness of the statements, are avoided…” Mr Long was asked in the application for insurance to give any hospitalisation. medical or surgical treatment in the past five years. He listed one such hospitalisation. He did not list two other pertinent hospitalisations which were material…. Regardless of the innocence with which such misrepresentation may have been made its misleading character is obvious, “nor can it be questioned that information thereof would have affected the conduct of the insurer to a very material extent.” Misrepresentations in an application for life policy need not be the sole inducement to the contract nor the chief

influence leading to action in order to relieve the insurer from liability, but it is enough if, as a contributory influence, they operate on the mind and conduct of the other party to any material extent… The appellant here was entitled to the information concerning the above mentioned hospitalisation as such hospitalisation does relate to a serious ailment material to the question of life expectancy and the withholding of same under the facts of this case is such a misrepresentation as to increase the risk of loss… It is therefore our opinion that the appellant was entitled to avoid the policy under the second alternative presented by Tit 28, § 6, Code of Alabama 1940; that is, that the matter misrepresented, to wit, two material hospitalisations, to wit, 12 May to 20 June 1966, and 20 July to 16 August 1966, which insured failed to disclose at the time of execution of the application for insurance, increased the risk of loss.’

[440] Illinois Insurance Code (1993) § 154. Misrepresentations and false warranties No misrepresentation or false warranty made by the insured or in his behalf in the negotiation for a policy of insurance, or breach of a condition of such policy shall defeat or avoid the policy or prevent its attaching unless such misrepresentation, false warranty or condition shall have been stated in the policy or endorsement or rider attached thereto, or in the written application therefore, of which a copy is attached to or endorsed on the policy, and made a part thereof. No such misrepresentation or false warranty shall defeat or avoid the policy unless it shall have been made with actual intent to deceive or materially affects either the acceptance of the risk or the hazard assumed by

the company. This section shall not apply to policies of marine or transportaton insurance.

5 Formation of the Insurance Contract 5.1 Introduction Leaving aside statutory insurance and similar schemes (see Part 1.8) insurance contracts are a subspecies of the genus contract, although they are a peculiar type of contract in that in many cases the insured will receive nothing tangible for the consideration paid since the event, which gives triggers the insurer’s liability, may never occur. In common with other contracts, for there to be a binding contract of insurance there must be an agreement between the insured and the insurer on the material terms. Typically, in non-marine business the prospective insured (the proposer) completes a proposal form and this amounts to the offer when it is received by the insurer. It is for the insurer to accept the proposal. [501] N Legh-Jones, J Birds and D Owen, eds, Macgillivray on Insurance Law, London,

Sweet & omitted]

Maxwell,

2003

[footnotes

‘2–2 An acceptance will be of no effect unless the parties have agreed upon every material term of the contract they wish to make. The materials terms are: the definition of the risk, the duration of the insurance cover, the amount and mode of payment of the premium and the amount of the insurance payable in the event of a loss. As to all these there must be a consensus ad idem, that is to say, there must be either an express agreement or the circumstances must be such as to admit of a reasonable inference that the parties were tacitly agreed.’

Note: Versions of this passage from MacGillivray have been widely cited with approval: for instance, De Mezey v Milwaukee Mechanics’ Insurance Co (1945) 12 ILR 122 (Alberta Supreme Court), Davidson v Global General Insurance Co 48 DLR (2d) 503, and Seymour v Wagstaff (1984) 52 NBR(2d) 86 (New Brunswick). [502] LP Martinez and JW Whelan, Cases and Materials on General Practice Insurance Law (2001, West Group: St Paul, Minn) at 56 ‘Courts of late have been keen to emphasise that an insurance policy is, fundamentally, a contract…The tacit message is that, as contracts, insurance policies should be treated under the general rubric of contract law.

Despite case-law admonitions to the contrary, insurance policies differ from traditional contracts. With a typical bilateral contract, the parties exchange performances and receive the benefits of performance simultaneously, and a breach is generally easily identifiable. With insurance policies, on the other hand, the insured tenders performance in the form of payments of premiums and the insurer is obligated to perform only if some event identified in the policy triggers performance — recall the concept of a condition precedent. Further, the insured typically does not assume an active role in negotiating or drafting the terms memorialised in the policy document itself.’

5.2 Offer and Acceptance An insurance contract is created in the same way as other types of contract and the analysis that the courts engage in to discover its existence is also the same. [503] Taylor v Allon [1966] 1 QB 304 (QB Divisional Court) Lord Parker CJ: ‘This is an appeal by way of case stated from a decision of justices for the North Riding of Yorkshire sitting at South Bank who convicted the defendant of using a motor car on a road when there was not in force in relation to the user of the vehicle such a policy of insurance and such a security in respect of third party risks as complied with Part VI of the Road Traffic Act, 1960, contrary to section 201 of that Act. The justices in the event, in my judgment quite rightly, fined him a nominal amount, some £2.

The short facts were these. The defendant was found using the motor car on a road on 15 April 1964. In fact he had been insured by an insurance company called the Federated Employers’ Insurance Association Ltd, the policy expiring on 5 April. On 18 April he obtained a temporary cover note for 30 days from a fresh insurance company, and there is a finding by the justices that on the expiration of the old policy he never intended to renew it with the old insurance company. The case is not very illuminating; we have been told that the defendant never gave evidence, but at some stage the solicitor appearing for him produced a temporary cover note from the old insurance company, purporting to cover him for 15 days commencing from and including 6 April, when the insurance policy expired. Accordingly, on 15 April when he used the vehicle, that extended cover was on the face of it in force. Bearing in mind that a valid insurance for the purposes of the section must arise from an enforceable contract, it seems to me that the contract, if any, contained in the temporary covering note must arise by offer and acceptance. It is conceded that the policy that expired had no provisions for extended cover, and accordingly this document sending this temporary covering note must in my judgment be treated as an offer to insure for the future. It may be, although I find it unnecessary to decide in this case, that there can be an acceptance of such an offer by conduct and without communication with the insurance company. It may well be, as it seems to me, that if a man took his motor car out on the road in reliance on this temporary cover, albeit that there had been no communication of that fact to the insurance company, there would be an acceptance, and that the contract so created would contain an implied promise by the insured to pay, either in the renewal premium when that was paid, or if it was not paid, for the period for which the temporary cover note had, as it were, been accepted.

I find it unnecessary in the present case to decide that matter, and for this reason, that it seems to me that the defendant must at any rate go to the length of saying that he knew of the temporary cover and that he took out his motor car in reliance on it. In fact, as I have already said, the defendant never gave any evidence at all. Further, from the justices’ clerk’s notes, which again we have been allowed to refer to, it appears that when he was stopped by the police and asked to produce his insurance certificate, he produced the old certificate of insurance which expired on 5 April, and he also produced the cover note from the new insurance company which commenced on 16 April. When the police pointed out that therefore on 15 April he was not covered, he not only did not refer to this temporary cover note, but he said then that he had been negotiating a change of insurance companies, and did not realise that it, presumably the original certificate, had run out. It was only at the hearing, and I think at the second hearing, that this temporary cover note, this extended cover, was produced by the defendant’s solicitor. In those circumstances it seems to me that the defendant has never gone to the length of showing that he knew of the temporary cover, that he acted in reliance on it, and thereby had accepted the offer contained in it. I think that the justices came to a correct decision in law and I would dismiss this appeal.’

Notes: 1. In Rust v Abbey Life Assurance Co [1979] 2 Lloyd’s Rep 334 (CA). Rust, who had been advised by the insurers and her own advisors, completed a proposal and sent it to the insurers. The insurers duly dispatched the

policy on terms different from those set out in the proposal. The court held that Rust’s application was an offer and the insurer’s action in sending out the proposal was an acceptance so that a contract existed. However, recognising that since the policy differed from the proposal it might be regarded as a counter offer by the insurer, the court held in the alternative that Rust’s delay of seven months in responding amounted to an acceptance. This was ‘an inevitable inference from the conduct of the plaintiff in doing and saying nothing for seven months’. 2. In Anderson v North America Life Assurance Company [1980] ILR 1–1267 (British Columbia Supreme Court), an insurer sent a premium notice for life assurance to the wrong person. That person paid, and the insurer accepted, the premium demanded. The court denied the insurer’s liability of the policy since the existence of a contract could not be inferred from the conduct of the insurer, either in issuing the notice or in receiving the premium. 3. Once acceptance has been communicated neither party can unilaterally withdraw from the agreement thereby formed, although in most jurisdictions legislation stipulates a “cooling off period” for certain types of insurance — typically, the so-called long-term business, such as life assurance or, in some places, where the transaction involves distance selling — during which the insured can withdraw (see

also the general cooling off period for insurance in General Insurance Standards Council General Insurance Code for Private Customers, para 3.9). [504] Canning v Farquhar (1886) 16 QBD 727 (CA) [On 8 December 1883 Mr Canning’s agent, Mr Walters, forwarded to Sun Life Assurance Society a proposal for life assurance which stated that Canning was in good health. On 14 December the insurer accepted the proposal and set an annual premium, but added that, ‘No assurance can take place until the first premium is paid.’ On 5 January, Canning fell over a cliff and was seriously injured; four days later, Walters tendered the premium and told the insurers of the accident. They refused to accept the premium. Canning later died. The Court of Appeal upheld the insurers denial of liability]. Lord Esher MR: ‘This seems to me to be a very important case in insurance law, and at the beginning of it I was much taken with the ordinary proposition that a proposal and an acceptance of that proposal make a contract. Whether that is so or not depends on whether the one was meant to be a proposal, and the other an acceptance by way of contract, and we are bound to look further and see what was the subject-matter. What is the contract of life assurance? It is this, “Taking the life to be good at the commencement of the risk I insure that life, for a year at a certain premium.” From this it is apparent that the material moment for the agreement as to

the state of health is when the risk commences, that is, at the beginning of the year, for it is not denied that the agreement is only for a year. Now it is said that before that year commenced there was a binding agreement to insure. But is it possible to say that when parties are discussing beforehand the conditions of the risk they mean to treat what they then say are the existing facts as binding them when the moment to make the contract arrives? No one can bind himself as to the state of his health a short time hence, and a man who makes a statement as to his state of health cannot mean to be bound as to what it will be a month hence, neither can the person to whom the statement is made be taken to rely on it further than as it may guide him in accepting the insurance or not. These considerations show that all these statements which are made preliminary to the moment of insurance are not considered by either party as contractual statements, but as expressions of intention on the one side to insure, on the other to accept the risk. That seems to me to be the view at which we must arrive looking at this as a business transaction. Now there is no case that supports affirmatively this view, but it is supported negatively by the fact that during all the years that life insurance has been known and practised, there is no case in the books or known to any one in which an action such as this has been maintained. These considerations are conclusive to my mind that what was said was preliminary to the contract of insurance, and was never intended by either party to be a contract in itself. From this it follows that after the insurance company have said that they accept the proposal, and that if the premium is paid they will issue a policy, although there is no change in the circumstances, and all that has happened is that they alter their mind, yet they are not bound to accept the premium. I do not shrink from saying that in my view of insurance law there is no contract in such a case binding them to accept the premium. If so this action fails, because

tender is only equivalent to payment if the person to whom the money is offered is bound to accept it. If the premium is offered and accepted there is at once an insurance, and the year for which the insurance runs commences then, and if the policy is drawn up properly that will appear in it. But then there is another view short of that. Supposing it to be true that after all the terms are agreed on, and the premium is offered, the company are bound to accept it, when does the contract of insurance commence? It commences at the time when the premium is offered, because in this case tender would be as good as payment. There is no insurance before that, but only a contract to the effect, “If you will offer the premium we will insure”. The only consideration any one can suggest for this contract is the trouble the man takes to bring his money. What then happens with regard to any previous examination or declaration of health, neither of which is material unless the company insist upon it. This is material, that the person to be insured should not conceal any material fact, and that his statements, if he makes any, should be correct. In this case the declaration was a representation which was true at the time it was made. In insurance law that is not the material time, but the material time is the moment when the insurance is made, and the representations ought to be true then. If there has been a material change there ought to be an alteration of the representation, and the ground for entering into the contract is altered. In this case the ground of the contract to give an insurance being changed, it was not binding on the society at the time of the tender of the premium, and they had a right to say “the circumstances are altered, therefore we will not insure,” even though, if the circumstances had not been altered, they would have been bound by their contract. It seems to me, therefore, that the appeal fails. In my opinion, however, the real ground for our decision is that the negotiations before the time when the policy is effected are mere statements of intention, and that

till the insurance company accept the premium they have a right to decline to accept the risk.’

Lindley LJ: ‘This action is for damages for breach of a contract to grant a policy on the life of Canning, and the question is whether the Sun Office was bound to issue a policy. This turns, it appears to me, on the question whether the office was bound to accept the premium which was tendered during the lifetime of Canning. It is said the office was so bound by contract, and we have to investigate this and see how it is made out. On 8 December Canning sent a proposal to the office. In that there was nothing about the premium that would be payable; with that document was a declaration of the truth of certain statements made by Canning, which was to be the basis of the contract…On 14 December the office made a communication to Canning, through Walters, that his proposal had been accepted subject to payment of a certain premium. I pause here for a moment to consider the effect of these negotiations. It was urged on the part of the plaintiff that there was then a complete contract binding the office on payment or tender of the premium to issue a policy of insurance. It is true that there had been an acceptance of Canning’s offer, but he had not at this time assented to the company’s terms; and until he assented to them there was no contract binding the company. The company’s acceptance of Canning’s offer was not a contract but a counter offer. Subsequently the premium was tendered, and I think there would be considerable difficulty, if there had been no change in the risk, in saying that the company, under such circumstances, might decline to accept the premium and issue the policy. In the case supposed the counter offer would be a continuing offer; the tender would be an acceptance of it, and the company would be bound to issue the policy. But the case supposed is not the case we

have to deal with here, because another element is introduced by reason of the material change in the risk in the interval between what I have called the counter offer and the tender of the premium. If Canning had tendered the money and had not informed the office of the alteration in the character of the risk, he would have been attempting to take advantage of an offer intended to cover one risk in order to make it cover another risk not known to the office. In other words, if he had paid the money without disclosing to the office the fact that his statements, which were true when he made them, were so no longer, he would have done that which would have been plainly dishonest. But that was not done — the alteration was disclosed, and the company refused to take the risk. I think they were perfectly justified in so refusing. It comes to this: there was no contract before the tender; and the risk being changed the company’s offer could not fairly be regarded as a continuing offer which Canning was entitled to accept. His tender was in truth a new offer for a new risk which the company were at liberty to decline. It appears to me, therefore, that this action fails, and the appeal ought to be dismissed.’

Notes: 1. On the duty of the insured to disclose material facts to the insurer, see chapter 4. In Looker v Law Union and Rock Insurance Co [1928] 1 KB 554 the insurers accepted a proposal for life assurance on the basis of the applicant’s warranty that he was free from disease. However, the insurers stated that the cover would not commence until the first premium had been paid. After the applicant received this letter but before the payment, he was

diagnosed with an illness from which he died four days later. The day before his death, the premium was paid, and the insurers, who had not been informed of the illness, sent him the policy. The insurers were not held liable. 2. The general rule is that cover starts once the contract has been made, irrespective of whether the premium has been paid, although, as in Canning and Looker, insurers do often stipulate to the contrary. Where the premium has been paid but the insurers were never on risk, then it must be refunded (Tyrie v Fletcher (1777) 2 Cowp 666 at 668, per Lord Mansfield CJ; Marine Insurance Act 1906, s 84(1)). 3. In some jurisdictions certain presumptions have been developed with regard to contract formation and the payment of the premium. In Alberta, for instance: ‘When the policy has been delivered the contract is as binding on the insurer as if the premium had been paid, although it has not in fact been paid’ (Insurance Act, R.S.A. 1980, c. 1–5 (Alberta), s 208(1))

See McDonnell v Wawanesa Mutual Insurance Co 102 DLR (3d) 561 (Alberta Supreme Court, 1980). In Australia and New Zealand cover is not dependent on proof of premium (Goodwin v State Government Insurance Office (1991) 6 ANZ Insurance Cases 77, 163 (Queensland Supreme Court), unless the contract specifies otherwise, although it usually does (Newis v General Accident, Fire and Life Assurance Corp (1910)

11 CLR 620 (High Court of Australia); Aetna Life of Australia & New Zealand v ANZ Banking Group Ltd [1984] 2 NZLR 718 (Court of Appeal, New Zealand). The courts in the US have shown themselves willing to impose liability on the insurer where the insured has completed a proposal and paid the premium and then there has been unreasonable delay in responding by the insurer. Different states have used different bases for this liability: negligent delay, under which the insurers are liable in tort where there is unreasonable delay; estoppel, which prevents the insurers from asserting that the delay did not amount to acceptance; contract, where the retention of the premium and failure to notify rejection within a reasonable period of time amounts to a contract; and implied agreement to act promptly. In addition to the cases extracted at [505], [506] and [507], see Moore v Palmetto State Life Ins Co 73 SE2d 688 (Supreme Court of South Carolina, 1952; Barrera v State Farm Mutual Auto Ins Co 456 P 2d 674 (Supreme Court of California, 1969); Independent Life and Accident Insurance Co v McKenzie 503 So 2d 376 (District Court of Florida, 1987); EM Holmes, Holmes’s Appleman on Insurance, 2d (1998, Lexis Law Publishing: Charlottesville, Va.), vol 3, chap 12. [505] Continental Life & Acc Co v Songer 603 P2d 921 (Court of Appeals of Arizona, 1979) Contreras J:

‘Our express recognition of the negligent delay theory is in accord with and justified by the precepts of individual consumer protection and the public interest. Because insurance companies are licensed and regulated by the state, they are part of an industry which is affected by the public interest…As a result, they can and should be held to a broader legal responsibility than are parties to purely private contracts. This is especially true in cases where the insurance carriers have solicited and obtained an application for insurance, and have received payment of a premium… In addition, and since insurance companies unilaterally prepare the applications and set forth the conditions for acceptance, the parties are not in an equal bargaining position. There must, in all fairness, be some degree of correlative consumer protection. We are of the opinion that an insurance company which retains an application for medical insurance that does not contain a provision as to the time within which the application must be acted upon, and also retains payment of a premium, may be held liable in damages if it fails to either accept or reject the application within a reasonable period of time. It is generally the rule that the determination of what constitutes a reasonable time is a question for the jury…’

[506] Ryan v Security Industrial Insurance Co 386 So2d 939 (Court of Appeal of Louisiana, 1980) Stoker J: ‘Although an insurer is granted a reasonable time to accept or reject an application, a period of 90 days is not a reasonable time. Since the insurer did not issue or reject the policy within a reasonable period of time, the insurer is estopped from denying coverage on the ground that the

policy was not issued until after the insured’s death. It would be inequitable to allow the insurer to receive, retain, and enjoy the benefits of premiums for a burial insurance policy, without issuing the policy, and then allow the insurer to deny coverage once the insured dies.’

[507] Smith v Westland Life Ins Co 539 P2d 433 (California Supreme Court, 1975) Sullivan J: ‘In Ransom [Ransom v Penn Mutual Life Ins Co 274 P2d 633 (1954)] we recognised that an ordinary person who pays the premium at the time he applies for insurance is justified in assuming that payment will bring immediate protection, regardless of whether or not the insurer ultimately decides to accept the risk. Subsequent cases have held the layman’s expectation of complete and immediate coverage upon payment of the premium to be so strong that if the insurer wishes to avoid its obligation of providing such protection it must not only use clear and unequivocal language evidencing its intent to limit temporary coverage pending its approval of the policy, but must also call such limiting condition to the attention of the applicant. In the absence of proof by the insurer that it satisfied both of these requirements, courts have held that the coverage provided under a temporary contract of insurance “is that which the ordinary layman, acting in the ordinary course of business, reasonably may expect by virtue of that transaction…” — namely, complete and immediate coverage upon payment of the premium. (Wernecke v Pacific Fidelity Life Ins Co 238 Cal App2d at p 887) …When, therefore, as in the case at bench, a contract of temporary insurance arises upon the insurer’s receipt of an application for insurance together with the first premium payment, the expectation of the applicant thereby given

recognition actually emerges from two conjoined acts — his signing of the application and his payment of the premium. In the words of Ransom “such a person would assume that he was getting immediate insurance for his money…” (at 635) This reasonable expectation on the part of the applicant would, in our view, extend to a continuance of such coverage until the insurer had nullified the two factors responsible for its existence — the application for the policy by rejection and notice of rejection, and the payment of premium by a refund of it. Unless the insurer “manifest(s) this intention (to refuse permanent coverage) by the return of the premium within a reasonable time,…the applicant could assume that his insurance was effective.” (Reck v Prudential Ins Co of America, 184 A. 777, 778…) A rule requiring that such temporary insurance can be terminated only by notice of rejection and refund of the premium appears to us to be not only logical but fair. It at once eliminates uncertainty as to coverage and controversy as to effective notice of rejection. When the insurer notifies the applicant of the rejection of his application but does not refund his premium, its action is uncertain and confusing. On the one hand, the notice of rejection indicates that the permanent policy the applicant requested will not be issued; on the other, the retention of the premium indicates that “(the) immediate insurance (he was getting) for his money” (Ransom, above at p 635) is still continuing. This uncertainty in which the applicant finds himself can be dissolved by conditioning termination on both notice of rejection and refund of premium. Such a rule will at the same time go far in eliminating risk of unfairness to the applicant where the circumstances surrounding the rejection of his application and notification thereof to him are disputed. Our decision to adopt this rule is fortified by the consideration recognized in Ransom that it is unconscionable for an insurance company to hold premiums without providing coverage.’ [Footnotes omitted]

Note: For a discussion of this idea in Canada, see Elite Builders Ltd v Maritime Life Assurance Company [1984] ILR 1–1798 (British Columbia Supreme Court). In Australia, it is an offence for an insurer, when asked by the prospective insured, to fail to give a reason where cover or renewal has been refused, or where renewal is given on less advantageous terms, although the insurer is provided with a defence and prosecution requires the Attorney-General’s consent (Insurance Contracts Act 1984, s 75).

5.3 Formalities In general, there are no special rules relating to the formation of an insurance contract. Although such contracts are commonly embodied in a document, there is no general requirement that they should be and, indeed, the fastest growing markets are in the provision of insurance over the telephone and through the internet: see Stockton v Mason and the Vehicle and General Insurance Co Ltd and Arthur Edward (Insurance) Ltd [1978] 2 Lloyd’s Rep 430. In some areas of insurance, however, legislation does require a written document. [508] Section 22 of the Marine Insurance Act 1906 (6 Edw 7 c41)

‘Subject to the provisions of any statute, a contract of marine insurance is inadmissible in evidence unless it is embodies in a marine policy in accordance with this Act. The policy may be executed and issued either at the time when the contract is concluded, or afterwards.’

Notes: 1. For the formal requirements of a marine policy, see sections 23–26. The provision in section 22 does not preclude the existence of a marine insurance contract based on an oral agreement, but it does prevent that contract from being enforced unless evidenced in writing. The practice in the London marine insurance market is to write a policy should litigation arise, but in any event it seems that ‘a slip may contain sufficient information to satisfy the Marine Insurance Act’ (HN Bennett, “The Role of the Slip in Marine Insurance Law” [1994] LMCLQ 94, 118). On the slip, see Part 5.6, below). 2. The Life Assurance Act 1774 does not expressly require that a life policy be written, but this is implicit in that it is unlawful ‘to make any policy or policies on the life or lives of any person or persons, or other event or events, without inserting in such policy or policies the person or persons name or names interested therein, or for whose use, benefit, or on whose account such policy is so made or underwrote.’ (s 2) A third-party motor policy can be made orally,

but the Road Traffic Act 1988 makes it an offence to use a car unless the insured has ‘a certificate of insurance’ from the insurer (sections 143, 145, 147, 165). In other statutes, documentation acts as notification to third parties of the existence of compulsory insurance and is, therefore, coupled with requirements concerning the display of a certificate of insurance: eg Employers’ Liability (Compulsory Insurance) Act 1969, s 4. [509] Insurance Act, RSA 1980, c 1–5, s 203(1) (Alberta) ‘All the terms and conditions of a contract of insurance shall be set out in full in the policy or by writing securely attached to it when issued, and unless so set out no term of the contract or condition, stipulation, warranty or proviso modifying or impairing its effect is valid or admissible in evidence to the prejudice of the insured or any beneficiary.’

Note: Under section 203(3) every policy must contain: the names of the insurer, the insured and the beneficiary under the policy; the amount of the premium; the subject matter of the insurance; the level of indemnity; the event which will give rise to liability; the dates on which the insurance takes effect and on which it terminates. However, none of these requirements prevents the parties from forming the contract orally (s 1(e.2)).

5.4 Mistakes The possibility of a mistake affecting the enforceability or formation of a contract is often removed by the fact that one of the parties has assumed the risk of there being such a mistake. [510] Section 6 Marine Insurance Act 1906 ‘where the subject-matter is insured “lost or not lost”, the assured may recover although he may not have acquired his interest until after the loss, unless at the time of effecting the contract of insurance the assured was aware of the loss, and the insurer was not.’

It is likely that the only other class of insurance where the parties can enter such a lost or not lost agreement is reinsurance. Where it is claimed that a written policy does not accurately represent the agreement, it may be possible to seek the equitable remedy of rectification: [511] Agip SpA v Navigazione Alta Italia SpA [1984] 1 Lloyd’s Rep 353 (CA) Slade LJ: ‘First, there must be common intention in regard to the particular provisions of the agreement in question, together with some outward expression of accord. Secondly, this common intention must continue up to the time of execution of the instrument. Thirdly, there must be clear evidence that the instrument as executed does not accurately represent the true agreement of the parties at

the time of its execution. Fourthly, it must be shown that the instrument, if rectified as claimed, would accurately represent the true agreement of the parties at that time’

Notes: 1. For examples of situations in which rectification was ordered, see Wilson, Holgate & Co Ltd v Lancashire & Cheshire Insurance Corpn Ltd (1922) 13 Ll L Rep 487; Eagle Star & British Dominions Insurance Co Ltd v A V Reiner [1927] 27 Ll L Rep 173. With regard to policies made at Lloyd’s, ‘Where there is a duly stamped policy, reference may be made, as heretofore, to the slip or covering note, in any legal proceeding.’ (Marine Insurance Act 1906, s 89; also Symington and Co v Union Insurance Society of Canton Ltd (No 2) (1928) 34 Com Cas 233 at 235, per Scrutton LJ (although see HN Bennett, “The Role of the Slip in Marine Insurance Law” [1994] LMCLQ 94). On the slip, see Part 5.6 below). 2. In other areas, mistake has always been something of a minefield, not least because of the confusion surrounding the ratio decidendi of the leading case, Bell v Lever Brothers Ltd ([1932] AC 161 (HL)), and the distinction made by some judges between mistake at common law and mistake in equity. In Bell v Lever Brothers Ltd, the House of Lords held that for a mistake to vitiate a contract it had to be common to both parties and be ‘something

which both must necessarily have accepted in their minds as an essential and integral element of the subject matter’ (at 235 per Lord Thankerton), or, to adopt Steyn J’s later explanation of the decision, the mistake ‘must render the subject matter of the contract essentially and radically different from the subject matter which the parties believed to exist’ (Associated Japanese Bank (International) Ltd v Credit Du Nord SA [1989] 1 WLR 255, 268). In Solle v Butcher [1950] 1 KB 671 and Magee v Penine Insurance Co Ltd (see [513]) it was held that Bell only referred to mistake at common law and that there was an additional category of mistake in equity. However, in Great Peace Shipping Ltd v Tsavliris Salvage (International) Ltd (see [514]) the Court of Appeal rejected this idea on the ground that it does not accord with the decision in Bell v Lever Brothers Ltd. In the following extracts, the judgment of Lord Denning in Magee is included to illustrate the position that has now apparently been rejected; that of Winn LJ, who dissented in Magee, now seems to represent the correct approach. [512] Scott v Coulson [1903] 2 Ch 249 (CA) [The parties entered a contract for the sale of a life policy in the belief that the assured life, Mr AT Death, was still alive. It later emerged that after the contract but before the actual assignment of the policy the

vendor received information, which he did not pass on to the buyer, indicating that Death might have died before the contract. That this was indeed the case was only confirmed after the assignment]. Vaughan Williams LJ: ‘On the facts of this case, if one takes those which were found by the learned judge in his judgment, I do not see what room there is for argument on any question of law. If we are to take it that it was common ground that, at the date of the contract for the sale of this policy, both the parties to the contract supposed the assured to be alive, it is true that both parties entered into this contract upon the basis of a common affirmative belief that the assured was alive; but as it turned out that this was a common mistake, the contract was one which cannot be enforced. This is so at law; and the plaintiffs do not require to have recourse to equity to rescind the contract, if the basis which both parties recognised as the basis is not true. Having regard to the evidence, it seems to be clear that the learned judge came to a right conclusion. If it had turned out that the vendors or their agent had requested Coulson to find out whether the assured was dead or alive, and Coulson had come back and said he could not find out, I should have said that, apart from argument, it would have been almost impossible to arrive at the conclusion that both parties had entered into the contract upon the basis that the assured was alive. But it turns out that no such inquiry was requested to be made. The only inquiry requested to be made was that contained in Coulson’s letter of 15 March 1902, in which he requested inquiry to be made about the assured. Therefore the inference cannot arise which, if it had arisen, would have been fatal to the plaintiffs’ contention that this contract was entered into upon the basis that the assured was still alive. If one gets rid of that,

what is there left? We have before us the conditions of the proposed sale which were before both parties, in which it certainly seems to be assumed that the assured was still alive. All I say with regard to the matter is that the material date all through is the date of the contract. If at that date a good contract was entered into, I cannot conceive that it could be rescinded. But it turns out that it was a contract entered into under a common mistake existing at the date of it, and therefore it follows that an assignment executed in pursuance of such a contract cannot be supported.’

Note: Strickland v Turner (1852) 7 Exch 208 concerned the sale of an annuity on the life of a person, who unknown to both buyer and seller had already died. It was held that the buyer was entitled to the return of the purchase price on the ground that there had been a total failure of the consideration. [513] Magee v Pennine Insurance Co Ltd [1969] 2 QB 507 (CA) [Thomas Magee bought a car in 1961. The salesman completed a proposal form for insurance which indicated Thomas Magee as the main driver, but which also noted that his two sons, including John Magee, would drive. The policy was renewed each year. Then in 1965 John Magee ran into a shop window, wrecking the car. The insurers wrote on 12 May agreeing to pay £385 and this offer was accepted. However, a few days later the insurers

discovered that Thomas Magee had never driven the car, indeed he had never driven any car. He admitted that the car was his son’s property and his son had been the only driver. The insurers refused to pay the £385. At the trial, the judge held that there had been no fraud by Thomas Magee.] Lord Denning MR: ‘Accepting that the agreement to pay £385 was an agreement of compromise. Is it vitiated by mistake? The insurance company were clearly under a mistake. They thought that the policy was good and binding. They did not know, at the time of that letter, that there had been misrepresentations in the proposal form. If Mr Magee knew of their mistake — if he knew that the policy was bad — he certainly could not take advantage of the agreement to pay £385. He would be “snapping at an offer which he knew was made under a mistake” and no man is allowed to get away with that. But I prefer to assume that Mr Magee was innocent. I think we should take it that both parties were under a common mistake. Both parties thought that the policy was good and binding. The letter of 12 May 1968, was written on the assumption that the policy was good whereas it was in truth voidable. What is the effect in law of this common mistake? Mr Taylor said that the agreement to pay £385 was good, despite this common mistake. He relied much on Bell v Lever Brothers, Ltd [1932] AC 161, and its similarity to the present case. He submitted that, inasmuch as the mistake there did not vitiate that contract, the mistake here should not vitiate this one. I do not propose today to go through the speeches in that case. They have given enough trouble to commentators already. I would say simply this: A common mistake, even on a most fundamental matter, does not make a contract void at law: but it makes it voidable in

equity. I analysed the cases in Solle v Butcher [1950] 1 KB 671, and I would repeat what I said there, at p 693: “A contract is also liable in equity to be set aside if the parties were under a common misapprehension either as to facts or as to their relative and respective rights, provided that the misapprehension was fundamental and that the party seeking to set it aside was not himself at fault.” Applying that principle here, it is clear that, when the insurance company and Mr Magee made this agreement to pay £385, they were both under a common mistake which was fundamental to the whole agreement. Both thought that Mr Magee was entitled to claim under the policy of insurance, whereas he was not so entitled. That common mistake does not make the agreement to pay £385 a nullity, but it makes it liable to be set aside in equity. This brings me to a question which has caused me much difficulty. Is this a case in which we ought to set the agreement aside in equity? I have hesitated on this point, but I cannot shut my eyes to the fact that Mr Magee had no valid claim on the insurance policy: and, if he had no claim on the policy, it is not equitable that he should have a good claim on the agreement to pay £385, seeing that it was made under a fundamental mistake. It is not fair to hold the insurance company to an agreement which they would not have dreamt of making if they had not been under a mistake. I would, therefore, uphold the appeal and give judgment for the insurance company.’

Winn LJ (dissenting): ‘This appeal has given me pleasure because it has been so well argued by both the counsel who have appeared in it; and, of course, the problem which it presents is not one the solution of which is going to impose frightful actual loss or consequences on the particular individuals or companies

who are involved. It is a neat and teasing problem, the difficulty of which is slightly indicated, though by no means established, by the regrettable circumstance that I find myself respectfully having to dissent from the views of my Lord and of my brother Fenton Atkinson LJ. I agree with my Lord that the letter of 12 May 1965, is of very great importance, though I take Mr Carman’s point, that it is not the insurers’ letter: it is only what purports to be a report, probably of a telephone conversation, written by the brokers, who were the agents of the plaintiff, Mr Magee, of what they were told by some representative of the defendant insurance company. I attach importance to it not because of its terms, which may not be an accurate representation of what the insurers had said, but because it contemplates a complete clearance of the whole matter and a termination of the dispute arising out of the claim, in so far as there was any, by return of various documents, which clearly was regarded as the final terminal phase of the matter. Whether or not this could be regarded, on a strict construction, as no more than an offer to fix a figure, which, subject to being liable to pay at all, the insurers were prepared to pay, seems to me to be excluded as a reality by the considerations which I have mentioned. This must have evinced an offer by the insurance company to dispose of the matter by paying £385 in settlement. As I see the matter, it is not a question of whether thereby a contract was formed, since it seems to me it is clear that there was a contract formed by that offer from the insurers and the acceptance of it again through the brokers by Mr Magee. The question is whether, as my Lord has indicated clearly, that contract is, for one reason or another, invalid and unenforceable by Mr Magee against the insurers. I do not desire to take long in expressing my opinion that on the principles of Bell v Lever Brothers, Ltd [1932] AC 161 applied to the circumstances of this case the contrary conclusion to that which my Lord has expressed is the

correct conclusion. It appears to me that the parties were under a misapprehension. If there was any misapprehension shared commonly by both Magee and the insurers as to what was the value of any rights that he had against them arising from the insurance policy, that seems to me to have been precisely the subject-matter of the common misapprehension in Bell v Lever Brothers, Ltd. One could pick out and read, and it would be instructive to re-read them many times, several passages from the speech of Lord Atkin, at p 210, and indeed also from that of Lord Thankerton, at p 229; but I content myself with the point made by Lord Atkin, when he said, at p 225: “Various words are to be found to define the state of things which make a condition.”; ie, a condition non-compliance with which will avoid a contract. And he instances, quoting them, the phrases: “In the contemplation of both parties fundamental to the continued ‘validity of the contract’, ‘a foundation essential to its existence’, ‘a fundamental reason for making it’ ” — all of which, as he said, were to be found in the judgment of Scrutton LJ in the same case; and Lord Atkin said, at p 226: “The first two phrases appear to me to be unexceptionable.” “But” — by contrast, he said — “a fundamental reason for making a contract may, with respect, be misleading.” And he goes on to give instances of such misleading assertions or misleading definitions of what is meant by a foundation essential to the contract. For my part, I think that here there was a misapprehension as to rights, but no misapprehension whatsoever as to the subject-matter of the contract, namely, the settlement of the rights of the assured with regard to the accident that happened. The insurance company was settling his rights, if he had any. He understood them to be settling his rights; but each of them, on the assumption that the county court judge’s view of the facts was right, thought his rights against the insurers were very much more valuable than in fact they were, since in reality they were worthless: the

insurers could have repudiated — or avoided, that being the more accurate phrase on the basis of the mis-statements which my Lord has narrated. Lord Thankerton also said, at p 235: “The phrase ‘underlying assumption by the parties,’ as applied to the subject-matter of a contract, may be too widely interpreted so as so [sic] include something which one of the parties had not necessarily in his mind at the time of the contract; in my opinion it can only properly relate to something which both must necessarily have accepted in their minds as an essential and integral element of the subject-matter.” I venture respectfully to contrast that sentence with any such sentence as this: — “which the parties both must necessarily have accepted in their minds as an essential reason, motive, justification or explanation for the making of the contract.” In my view the mistake must be a mistake as to the nature or at the very least the quality of the subjectmatter and not as to the reason why either party desires to deal with the subject-matter as the contract provides that it should be dealt with. And Lord Thankerton also said, at p 236: “I think that it is true to say that in all” the cases — and he is referring to a number of them — “it either appeared on the face of the contract that the matter as to which the mistake existed was an essential and integral element of the subject-matter of the contract, or it was an inevitable inference from the nature of the contract that all the parties so regarded it.” …For the reasons which I have endeavoured to state quite briefly — though I think there are many other considerations which are relevant to this interesting problem — I find

myself, respectfully and diffidently, unable to agree with the judgment of my Lord.’

Note: In Associated Japanese Bank (International) Ltd v Crédit du Nord SA [1989] 1 WLR 255, Steyn J said, ‘No one could fairly suggest that in this difficult area of the law there is only one correct approach or solution. But a narrow doctrine of common law mistake (as enunciated in Bell v Lever Bros Ltd [1932] AC 161), supplemented by the more flexible doctrine of mistake in equity (as developed in Solle v Butcher [1950] 1 KB 671 and later cases), seems to me to be an entirely sensible and satisfactory state of the law: see Sheikh Bros Ltd v Ochsner [1957] AC 136. And there ought to be no reason to struggle to avoid its application by artificial interpretations of Bell v Lever Bros Ltd.’

In spite of this the Court of Appeal has recently declined to follow Solle and Magee must, therefore, be incorrect. [514] Great Peace Shipping Ltd v Tsavliris Salvage (International) Ltd [2003] QB 679 (CA) Lord Phillips MR: ‘We do not find it conceivable that the House of Lords overlooked an equitable right in Lever Bros to rescind the agreement, notwithstanding that the agreement was not void for mistake at common law. The jurisprudence established no such right. Lord Atkin’s test for common

mistake that avoided a contract, while narrow, broadly reflected the circumstances where equity had intervened to excuse performance of a contract assumed to be binding in law… A number of cases, albeit a small number, in the course of the last 50 years have purported to follow Solle v Butcher [1950] 1 KB 671, yet none of them defines the test of mistake that gives rise to the equitable jurisdiction to rescind in a manner that distinguishes this from the test of a mistake that renders a contract void in law, as identified in Bell v Lever Bros Ltd [1932] AC. This is, perhaps, not surprising, for Denning LJ, the author of the test in Solle v Butcher, set Bell v Lever Bros Ltd at nought. It is possible to reconcile Solle v Butcher and Magee v Pennine Insurance Co Ltd [1969] 2 QB 507 with Bell v Lever Bros Ltd only by postulating that there are two categories of mistake, one that renders a contract void at law and one that renders it voidable in equity. Although later cases have proceeded on this basis, it is not possible to identify that proposition in the judgment of any of the three Lords Justices, Denning, Bucknill and Fenton Atkinson, who participated in the majority decisions in the former two cases. Nor, over 50 years, has it proved possible to define satisfactorily two different qualities of mistake, one operating in law and one in equity. In Solle v Butcher Denning LJ identified the requirement of a common misapprehension that was “fundamental”, and that adjective has been used to describe the mistake in those cases which have followed Solle v Butcher. We do not find it possible to distinguish, by a process of definition, a mistake which is “fundamental” from Lord Atkin’s mistake as to quality which “makes the thing [contracted for] essentially different from the thing [that] it was believed to be”: [1932] AC 161, 218. A common factor in Solle v Butcher and the cases which have followed it can be identified. The effect of the mistake

has been to make the contract a particularly bad bargain for one of the parties. Is there a principle of equity which justifies the court in rescinding a contract where a common mistake has produced this result? …[T]he premise of equity’s intrusion into the effects of the common law is that the common law rule in question is seen in the particular case to work injustice, and for some reason the common law cannot cure itself. But it is difficult to see how that can apply here. Cases of fraud and misrepresentation, and undue influence, are all catered for under other existing and uncontentious equitable rules. We are only concerned with the question whether relief might be given for common mistake in circumstances wider than those stipulated in Bell v Lever Bros Ltd [1932] AC 161. But that, surely, is a question as to where the common law should draw the line; not whether, given the common law rule, it needs to be mitigated by application of some other doctrine. The common law has drawn the line in Bell v Lever Bros Ltd. The effect of Solle v Butcher [1950] 1 KB 671 is not to supplement or mitigate the common law: it is to say that Bell v Lever Bros Ltd was wrongly decided. Our conclusion is that it is impossible to reconcile Solle v Butcher with Bell v Lever Bros Ltd. The jurisdiction asserted in the former case has not developed. It has been a fertile source of academic debate, but in practice it has given rise to a handful of cases that have merely emphasised the confusion of this area of our jurisprudence…If coherence is to be restored to this area of our law, it can only be by declaring that there is no jurisdiction to grant rescission of a contract on the ground of common mistake where that contract is valid and enforceable on ordinary principles of contract law. …In this case we have heard full argument, which has provided what we believe has been the first opportunity in this court for a full and mature consideration of the relation between Bell v Lever Bros Ltd [1932] AC 161 and Solle v

Butcher. In the light of that consideration we can see no way that Solle v Butcher can stand with Bell v Lever Bros Ltd. In these circumstances we can see no option but so to hold. We can understand why the decision in Bell v Lever Bros Ltd did not find favour with Lord Denning MR. An equitable jurisdiction to grant rescission on terms where a common fundamental mistake has induced a contract gives greater flexibility than a doctrine of common law which holds the contract void in such circumstances. Just as the Law Reform (Frustrated Contracts) Act 1943 was needed to temper the effect of the common law doctrine of frustration, so there is scope for legislation to give greater flexibility to our law of mistake than the common law allows.’

Notes: 1. For comments on this case, see (2003) 62 CLJ 29; [2002] LMCLQ 449; (2003) 119 LQR 177, 180. 2. The decision in Scott v Coulson (see [512]) survives this revision of the case law. Lord Phillips remarked, ‘The policy…was very far from a nullity. The only way that the case can be explained is by postulating that a life policy before decease is fundamentally different from a life policy after decease, so that the contractual consideration no longer existed, but had been replaced by something quite different — ergo the contract could not be performed. Such was the explanation given by Lord Thankerton in Bell v Lever Bros Ltd…[at 236].’

5.5 Cover Notes and Renewals Insurers often issue a cover note providing temporary insurance pending the formal policy or in order to give them time to consider whether to take on the risk for the full term. These cover notes are contractual documents and are subject to the normal principles of insurance contract law, including the duty of disclosure. The terms of cover may, however, differ from those included in the policy. [515] Re Coleman’s Depositories Ltd and Life & Health Assurance Association [1907] 2 KB 798 (CA) Buckley LJ: ‘For the purposes of the decision of this case the material facts taken from the award [by the arbitrator] are as follows. On 28 December 1904, the employers [Coleman’s] signed the proposal, and by the hands of Moran, Galloway & Co as their agents received the covering note from the insurance company. The premium was duly paid, not, it is true, at that time, but at a later date. The award, however, finds as a fact that as between the insurance company and the assured the premium is to be treated as having been paid. On 2 January 1905, a risk covered by the proposal and covering note resulted in a claim. At that date the assured had no knowledge of the condition now relied upon. The absence of such knowledge is not stated in the award, but knowledge (if it existed) was a fact for the insurance company to prove, and they have not proved it. On 9 or 10 January the policy was received by Moran, Galloway & Co, and delivered by them to the employer. The policy contained a condition that

“the employer shall give immediate notice to the association of any accident.” The whole matter for decision before us is whether the failure of the employer to comply with that condition affords a good defence to this particular claim. In my opinion it does not. On 2 January the employer had no knowledge of the condition which was subsequently disclosed by the policy. It was impossible, therefore, that he should comply with a condition which required that he should give immediate notice to the association of the accident which occurred on 2 January for he had at that time no knowledge that it was required of him. The policy when delivered was dated 3 January and was to be in force from 1 January 1905. But upon these facts the true inference in my opinion is that the insurance office, as regards this risk which had resulted in a claim before knowledge of the condition was created, never imposed that condition. The point is not that there was waiver of a condition which was applicable to this risk. It is that the condition never became applicable to this risk. Upon this ground I think that the appeal fails.’

Note: 1. See Car Owners’ Mutual Insurance Co Ltd v Buckley (1986) 81 FLR 424 (Australian Capital Territory, Supreme Court). 2. This problem can also be seen in the provision of cover over the telephone (the internet provides the opportunity for an insurer to supply full policy terms). Where, for example, a motorist is seeking cover over the telephone, in practice insurers ask some fairly basic questions concerning age, motoring convictions and so forth, which go to the duty of disclosure and

tend to give very little, if any, information about the terms. This creates a difficulty for the insurer in that cover is commonly provided from the time of the call (or shortly after) and before any paperwork is received by the motorist. The question is, what are the terms of such a contract? In the case of a new policy, it seems likely that the motorist would expect, and a court would imply, terms that might reasonably be expected in such a policy. However, the Unfair Terms in Consumer Contracts Regulations 1999 state that a term will be unfair where it has the effect of ‘irrevocably binding the consumer to terms with which he had no real opportunity of becoming acquainted before the conclusion of the contract’. (sch 2, para 1(i)). If the motorist were merely renewing cover, the presumption would be that the terms of the old contract would apply to the new one. [516] CE Heath Underwriting & Insurance (Australia) Pty Ltd v Edwards Dunlop & Co Ltd 176 CLR 535 (High Court of Australia, 1993) Dawson, Toohey and McHugh JJ: ‘The distinction between the renewal of a policy and the extension of a policy was expressed in the following terms by Mayo J. in Re Kerr:

“Strictly, a ‘renewal’ is descriptive of a repetition of the whole arrangement by substituting the like agreement in place of that previously subsisting, to be operative over a new period, whereas an ‘extension’ betokens a prolongation of the subsisting contract by the exercise of a power reserved thereby to vary one of its provisions, that is, by enlarging the period. Upon a renewal similar rights revest… A contract reserving continuous rights of renewal will, if these be exercised, lead to succeeding contracts in a series, the identity of each contract [being] separate and distinct. On the other hand, the exercise of the right of extension augments the length of time over which the contract operates, without changing its identity.” Whether there is a renewal or an extension of an insurance policy is a question of construction, the term “renewal” often being used to refer to both “renewal” and “extension” in the sense that those words are used above. It is, however, well established that, where a policy is renewable only by mutual consent (ie not as of right), the renewal results in a fresh contract rather than an extension of an existing contract. Of course, a policy may expressly stipulate that it is not to continue in force beyond the period of insurance, unless renewed by mutual consent. And where a policy, such as the ordinary form of life policy, expressly provides for continuation beyond the specified period of insurance unless a particular event, such as the nonpayment of the premium, takes place, the renewal is an extension of the original contract. But where a policy is silent on the question of renewal, renewal of it will generally constitute a new contract.’

Notes:

1. Where there is a renewal in the sense in which Mayo J used the word and it is, therefore, treated as a fresh contract, the duty of disclosure arises again and new terms may be introduced; if new terms have not been incorporated into the policy, the original terms will apply (GNER v Avon Insurance plc [2001] 2 All ER (Comm) 526 (CA)). 2. A renewal notice will often be sent before the expiration of the old policy and will give the insured a period within which to pay the renewal premium. The offer will lapse after the expiry of the specified period: Maguire v AMP Fire & General Insurance Co Ltd (1982) 2 ANZ Ins Cas 60–470 (High Court of New Zealand). However, in Australia under the Insurance Contracts Act 1984 (Cth), section 58, the insurers must give at least 14 days notice of the expiry of cover and at that time inform the insured whether they are prepared to contemplate renewal. Even more thrilling for the insured is that if this is not done the renewed policy will be free of charge unless a claim is made, in which event a formula for calculating the premium comes into operation (section 58(4)). Australian case-law also favours the view that, on renewal, the insurers should point out to the insured any change in terms: Forbes v Australian Motor Insurers Ltd (1990) 6 ANZ Ins Cas 61–015 (Supreme Court of Tasmania). Indeed, Professor Sutton has suggested that under Australian law this is part

of the insurers’ duty of disclosure (see K. Sutton, Insurance Law in Australia, (Sydney, Information Services,1999) at 60). English law does not require insurers to inform an insured of the imminent expiration of a policy. However, aside from considerations of good business practice, the General Insurance Standards Council requires its members, which includes insurers as well as intermediaries, to give both private and business customers such notice (see the Code for Private Customers, para 5.3 and Commercial Code, para 32. See further, chapter 3). 3. In neither English and Australian law is there substance to the idea that where cover has expired and renewal is offered an insured is covered for a reasonable time after the expiry of the old policy, unless this can be gathered from the circumstances: Mobili Pty Ltd v FAI Insurance Ltd (1986) 4 ANZ Ins Cas 60-718 (New South Wales, Supreme Court).

5.6 Insurance at Lloyd’s Lloyd’s has particular rules about the formation of insurance contracts (for the history and regulation of Lloyd’s, see chapter 2, Part 2.5). A prospective insured cannot go directly to the Lloyd’s market, but must go through a Lloyd’s broker or an outside agent guaranteed by a Lloyd’s broker. The broker, acting as the agent of the prospective insured, writes a slip

outlining the risk and then approaches an underwriter (see [520]; HN Bennett, “The Role of the Slip in Marine Insurance Law” [1994] LMCLQ 94). The underwriter, who wishes to take on the risk, initials the slip. Where the subject matter to be insured has a high value, it is likely that the underwriter will be unwilling to take on the whole of the risk. In such cases, the broker obtains the initials of an underwriter specialising in this type of risk (the “leading” underwriter) and then seeks the subscription of other underwriters (“following” underwriters) until the slip is fully subscribed. Once the slip is fully subscribed, a policy can be issued by the Lloyds Policy Signing Office, although in practice policies are often not issued, unless required, as, for instance, would be the case where a claim is made and liability disputed. Several legal issues arise out of these practices. One is the problem of how many |contracts there are. Is there a single contract to which all the underwriters are parties, or is there a separate contract with each underwriter? Another problem is that any misrepresentation made to the leading underwriter would not be actionable by the following underwriters unless it is repeated to them. Where the following underwriter has subscribed because of the subscription of the leading underwriter, or has subscribed as a way of encouraging the broker to place other business, then the representation has not induced the following underwriter to enter the contract. Other problems arise where circumstances have changed while the broker is obtaining

subscriptions, or a following underwriter subscribes on different terms, or the broker fails to obtain subscriptions for the entire risk, or the broker obtains subscriptions that exceed the risk. In addition to the following cases, see Rozanes v Bowen (1928) 32 Ll L Rep 98; Youell and Others v Bland Welch & Co Ltd and Others [1992] 2 Lloyd’s Rep 127 (CA), see [908]; BP Plc v GE Frankona Reinsurance Ltd [2003] 1 Lloyd’s Rep 537, see [909]). [517] General Accident Fire and Life Assurance Corporation v Tanter (The ‘Zephyr’) [1984] 1 Lloyd’s Rep 58 Hobhouse J: ‘Another point which emerged clearly from the evidence was that the slip is the record of the contract between the assured and the underwriter. It is the contract; it is not merely evidence of an oral contract; it is not open to either party to contend that part of the contract between the assured and the underwriter is to be found elsewhere. In this the evidence correctly reflected the legal position as stated by the Courts; see for example Mr Justice Matthew in Thompson v Adams, (1889) 23 QBD 361 at p 365 and Lord Justice Roskill in American Airlines Inc v Hope [1973] 1 Lloyd’s Rep 223 at p 243. Thus if something is agreed between the underwriter and the broker as part of the contract between the underwriter and the assured it must be written in the slip. It is of course conceptually possible to make a contract which is partly oral and partly written but that is not the practice of the market. The contract is the slip. What the broker says may ‘of course’ be a representation or disclosure and affect the validity of the contract. But any agreement with the broker not

incorporated in the slip will not be part of the contract with the assured. There are good practical reasons for this. A single slip leads to a single policy or to split but identically worded policies. The policy is the formal contractual document issued to the assured and unequivocally contains the terms of the contract. The practice could not accommodate slips or policies which did not correctly record the terms of the contract with the assured. Another practical reason is that later underwriters subscribe slips in part on the faith of the subscription of the leaders and the earlier underwriters. The later underwriters are entitled to believe that those subscriptions are to an insurance contract in the terms written on the slip. If this belief was not to accord to the true position, the market could not operate in the way it does.’ [Decision reversed on appeal, but on grounds that did not relate to this issue: see [518].]

[518] General Accident Fire and Life Assurance Corporation v Tanter (The ‘Zephyr’) [1985] 2 Lloyd’s Rep 529 (CA) Mustill LJ: ‘First, as to the practice in the London market. As in the case of direct insurance, the business is offered to the reinsurer in the form of a slip, tendered by the broker to the underwriter. If the underwriter decides to accept the whole or part of the risk, he signifies this by placing his initials on the slip, against a statement of the amount which he is prepared to accept. This statement may be expressed in various ways. In the case of this particular reinsurance, which was concerned with total loss only, the underwriters wrote their lines as percentages of the value of the ship. Naturally, the broker sets out to obtain from the underwriters a series of lines totalling the whole amount of the risk. He will not, however, necessarily be content with

this. He is entitled, according to the practice in the London market, to continue with the collection of subscriptions, to the extent that, on the face of it, the slip will reflect a series of contracts which provide the assured or reassured with a greater amount of cover than he has instructed the broker to obtain. This anomaly is dealt with by an automatic implied adjustment of the individual contracts of reinsurance — the precise juridical basis of which need not be explored — whereby each line is proportionally reduced so as to ensure that the subscriptions add up to 100 per cent and no more. A slip which undergoes this process is said to be “signed down”. When each line is automatically adjusted in this way to a particular percentage of the amount originally initialled it is said to have signed down to that percentage. Since English law recognises that risks may be written retrospectively, the broker may legitimately continue to obtain further subscriptions, and hence to increase the degree of signing down, after the risk has attached. On the other hand, if the vessel suffers a casualty while the slip is being taken round the market, the extent of signing down is to be determined at the moment when the loss is known to the assured or the broker, since thereafter the risk can no longer properly be offered to further underwriters. A large part of the art of underwriting consists of choosing the size of the line which is written. An underwriter will incline towards writing a line on any slip tendered to him, in order not to discourage the broker from offering him more interesting business in the future. If the risk is unattractive, he will try to make the line as small as possible. If the broker offers a series of risks at the same time, in the shape of a package, some attractive and others not, the underwriter will often write a line on an unattractive risk, as small as he is allowed, in exchange for the chance to write a larger line on the others. Since the magnitude of the risk ultimately borne by the underwriter will be determined, not only by the

percentage which he writes against his initials, but also by the degree to which the slip is signed down — a matter not within the underwriter’s control — any underwriter who is interested in the effect of writing the risk on his total exposure or on his premium income will necessarily be interested in the extent to which the slip will be signed down. He can, if he wishes, protect himself by inscribing one of the various formulae against the stated percentage, to indicate that this percentage is to represent his firm exposure. This solution is not much used in the particular type of insurance with which this appeal is concerned. In its absence, the underwriter may obtain a degree of safeguard by obtaining from the broker a signing down indication — namely a statement by the broker as to the percentage of the written line which he believes the underwriter will actually have to bear when the process of signing down is completed. On some occasions the broker will volunteer this information; on others, he will give it in response to a direct question; on others still, it is not given at all. There is no invariable form of words for such an indication. The broker may say “It will sign down to 40 per cent”, or “I think it will sign down to about 40 per cent;” or “It will sign down to 40 per cent at most;” or he may use some other formula. Although in many respects the writing of reinsurance business takes the same shape as in the case of direct insurance, it has one special feature which has led to many of the problems debated at the trial and on this appeal. When a primary insurer is deciding whether or not to take a line on a particular risk, and if so in what amount, he may decide to participate only if he can obtain reinsurance. In such a case the broker will have a better prospect of persuading the underwriter to participate in the primary insurance if he is able to offer him reinsurance at the same time. Accordingly, a practice has developed whereby a broker instructed to obtain a primary cover will on his own initiative approach potential reinsurers to obtain from them

in advance a binding promise to provide reinsurance for whatever person may subsequently write a line on the primary cover and desire to reinsure the whole or part of that line. The reinsurer conveys this promise by initialling a percentage line on a slip, which identifies the subjectmatter, the nature of the risk and the value. The slip does not, however, identify the reassured and could not do so: for at the stage when the potential reinsurer is approached, it is not known whether the primary insurance will ever be written at all, and if so by whom; or whether any of the primary insurers will desire to effect reinsurance; or whether any insurer who does desire to reinsure will be willing to do so with the reinsurer whom the broker has approached, and on the terms which he has offered. With this promise “at large” in his pocket, the broker can offer to an underwriter a package consisting of the opportunity to take a line on the primary cover, and at the same time to place an order for reinsurance. It can readily be seen that the practice of oversubscription and signing- down applies in a special way to the broking of reinsurance in advance. Where a primary insurer initials a percentage line, both he and the broker know that the percentage which he will actually bear in practice will depend solely upon the extent to which the broker goes on recruiting subscribers after 100 per cent of the risk has been written. This will also be one of the controlling factors in the case of reinsurance, but there are other factors as well: namely, the extent to which the primary insurers place orders for reinsurance, and the extent to which the lines written by those of them who have placed orders are signed down by oversubscription of the primary slip.’

[519] General Reinsurance Forsakringsaktiebolaget

Corporation v Fennia Patria

[1983] QB 856 (CA) Kerr LJ: ‘In every insurance or reinsurance transaction the object of the insured is to secure a contract which provides him with the full desired cover on acceptable terms. But where the risk is not covered by one insurer, as it is in the tariff market, and the slip method of participation is used, it is clear that the total cover results, both in fact and in law, from the conclusion of the individual contracts made with the various syndicates or companies on whose behalf the participating lines are written. An ordinary lay insured may not appreciate this, but a professional insurer who seeks reinsurance will know that this is so. In either case, if and when a claim arises, the legal position is that the insured or reinsured can only claim against the individual insurers to the extent of the proportion which they have underwritten… [T]he slip method of placing insurance results in the conclusion of separate contracts with the subscribers of the slip. However, in placing the desired cover in this way, the completion of the slip may well take days and sometimes weeks. In the great majority of cases, the first line, written by the leading underwriter on the slip as presented to him, will be followed by the remainder writing different proportions — whether by way of percentage or amount — on identical terms and at the same rate of premium until the 100 per cent subscription has been achieved. But in some cases this may not happen, because the subsequent underwriters may insist on different terms to which the broker may agree, albeit reluctantly, or because there may be some other intervening event, such as a change of circumstances or a change of mind by the insured, or because of the inability of the broker to procure completion of the slip up to 100 per cent on any terms which are acceptable to him. In such cases, apart from the problem

concerning the status of the lines already written which arises in the present case, the position will be unsatisfactory to the insured, because his initial object of obtaining 100 per cent cover on identical terms will not have been achieved. It will also be administratively unsatisfactory in the market, because one insured or reinsured risk will have been written on different terms. In the present case Staughton J described this situation as follows at [1982] QB 1022, 1039B–C, referring to the evidence of one of the witnesses and to the decision of Donaldson J in Jaglom’s case [[1972] 2 QB 250]: “These difficulties are not of course insuperable. The position was summed up by Mr Shaw in his evidence: market practice abhors a slip on different terms; it is possible, but daft. This too was one of the consequences which Donaldson J described as absurd.” In order to deal with the difficulties which may arise before a slip has been fully subscribed, the judge listed a number of situations in which these problems may fall to be resolved… [I]t is convenient to set them out again in slightly different terms: (a) The broker may obtain subscriptions for part of the risk and be unable to obtain any more. (b) The broker may obtain subscriptions for part of the risk and then his client may decide that insurance is not required. (c) The broker may obtain subscriptions for 100 per cent of the risk, and then his client may decide that insurance is not required. (d) The broker may obtain subscriptions for more than 100 per cent of the risk. (e) Underwriters subsequent to the leading underwriter may alter the terms of the slip. (f) Situations similar to (a), (b), (c) and (e) may arise with a slip amending an existing insurance contract, ie, an “indorsement” slip as opposed to an original slip. (g) Any of the above situations may arise (i) before the risk has commenced (or “incepted”), or (ii) after it has commenced.

It will be noted that in this list the judge makes no reference to cases where a loss giving rise to a claim arises after the partial, and before the complete, subscription of the slip, and I shall have to return to this point later on. Three matters should be mentioned in the context of this list of possible situations. First, as the judge points out at the end of this passage, where a broker wishes to test the market, it is always open to him to circulate a “quotation slip,” viz, one which makes it plain that he is merely seeking a quotation rather than a contract, so that he can then decide whether or not to proceed by means of an unqualified slip on the same or different terms. Secondly, the situation referred to in (d) requires some explanation. It may often happen, when all the subscriptions on the slip are added up, that these will be found to total more than 100 per cent; indeed, the broker may not discourage excessive subscriptions, because the degree of interest and participation may give him some indication about the attitude of various underwriters for the future if the cover is to be renewed after its expiry or to be increased in the interim. Provided that this over-subscription does not occur to an unreasonable extent, it is accepted by the subscribers of a slip, albeit perhaps reluctantly, that upon the ultimate “closing” — which they may not receive for weeks or even months after they have written their line — this may fall to be written down proportionately to some extent, so that the total subscription does not exceed 100 per cent. The judge dealt with this…as a recognised and binding practice of the market, and this was fully accepted on the present appeal. Thirdly, it was common ground before the judge, as well as on this appeal, that the problems raised by the various situations listed above fall to be resolved in the same way, irrespective of whether the transaction is one of insurance or reinsurance, or whether the slip is an original slip or an indorsement (or amendment) slip which is circulated during the period of the cover, or whether it is a marine or non-

marine risk. It was also accepted that no distinction is to be drawn between insurances at Lloyd’s and those placed by means of slips in the company market. However, given the fact that every line may require to be written down proportionately to some extent, in order to produce a total cover of no more than 100 per cent, there remains the crucial question as to the contractual status of each line once it has been written and before the slip has been completed. In this connection the first consideration is the decision of Donaldson J in Jaglom’s case [1972] 2 QB 250 to which I have already referred. The judge discussed this case in detail…His conclusions were accepted by both parties, and I can therefore deal with the case somewhat more shortly. It concerned a slip which took several weeks to complete and which was amended in different respects by subsequent underwriters during this process. After it had been completed there was a loss, and the resulting claim was resisted by the leading underwriter on behalf of all the subscribers of the slip. The issue turned on the true construction of the slip in the context of the events which had taken place. As appears from the arguments [1972] 2 QB 250, 252–54, both parties proceeded on the basis of the terms of the slip in its finally amended form, irrespective of the chronology of the amendments in relation to the lines as these were written. No issue appears to have been raised as to the status of each line in relation to the slip as it then stood, and there was no argument or evidence as to what the contractual position in this respect was considered to be, either by custom or implication. However, in an obiter passage in his judgment…Donaldson J concluded that each line represented an offer by the underwriter in question on the basis of the slip as it then stood, and that a binding contract only came into existence when the slip had been fully subscribed. It would therefore follow from this analysis that no contractually binding commitment is accepted by

any underwriter when he writes a line. In the present case, in which considerable evidence as to the custom or practice of the market was adduced, this conclusion was rejected by all the witnesses. Accordingly the correctness of the analysis in Jaglom’s case was not supported by either party on this appeal, and there was no cross-appeal by the plaintiffs against the conclusion of Staughton J that to this extent Jaglom’s case should not be followed. Nevertheless, since the decision has been reported and discussed in several of the textbooks to which the judge refers, we felt it necessary to consider it afresh, bearing in mind that if it is correct in law it cannot be ousted by agreement between the parties. Having done so, and with respect to Donaldson J who did not have the benefit of any argument or evidence on this point, I am in no doubt that Staughton J was right in the present case in concluding… that the orthodox understanding of the position is correct, viz, the presentation of the slip by the broker constitutes the offer, and the writing of each line constitutes an acceptance of this offer by the underwriter pro tanto. The evidence in the present case clearly shows that in the insurance market this is the intention of both parties to the transaction, and the legal analysis must accord with their intention Where an underwriter varies the terms of the slip with the consent of the broker before writing his line, this would accordingly constitute a counter-offer which is accepted by the broker on behalf of his client. In connection with the decision in Jaglom’s case [1972] 2 QB 250 I would only add that, since the hearing of this appeal, I discovered, more or less by chance, that the foregoing conclusion is in fact borne out by one authority cited in Chalmers’ Marine Insurance Act 1906, 8th edn (1976), p 36 in the notes to section 21, which deals with the “Slip or covering note or other customary memorandum of the contract,” and which concerned an uncompleted slip. This is Morrison v Universal Marine Insurance Co (1872) LR 8

Ex 40 and on appeal to the Exchequer Chamber (1873) LR 8 Ex 197. It is not mentioned in any of the textbooks in their discussion of Jaglom’s case, but it shows that the understanding in the insurance market has differed from Jaglom’s case for more than a century. In that case a broker was instructed to obtain cover for £5,000, respectively, on a vessel and her chartered freight. He then received information suggesting that the vessel had stranded, but was doubtful as to its accuracy and procured a line of £500 on chartered freight from the underwriter of the defendants. The news of the stranding then became known and thereafter, as appears from the unanimous judgment on appeal, at p 206, “the broker could not succeed in covering the ship or freight for any amount beyond that already effected.” The action was accordingly brought to recover the sum of £500 in relation to the only line which had been written. The issue concerned the direction to the jury as to whether the subsequent issue of a policy in terms of the partially completed slip constituted an election by the insurers not to rely on the non-disclosure. For present purposes the importance of the case is that, on behalf of the underwriters, “it was admitted that in effecting marine insurances the matter is considered merely as negotiation till the slip is initialled, but when that is done the contract is considered to be concluded,” notwithstanding that the slip had only been partially subscribed: see LR 8 Ex 40, 45 and LR 8 Ex 197, 199. I therefore proceed, as did Staughton J and both parties on this appeal, on the basis that each line written on a slip gives rise to a binding contract pro tanto between the underwriter and the insured or reinsured for whom the broker is acting when he presents the slip. The underwriter is therefore bound by his line, subject only to the contingency that it may fall to be written down on “closing” to some extent if the slip turns out to have been oversubscribed. The crucial issue, however, is whether the

insured or reinsured is also bound to the same extent, or whether — as the defendants contend and Staughton J accepted — the latter have an option to rescind the contract thereafter, at any rate until the time when the slip is fully subscribed to the extent of 100 per cent or more. The defendants contend that until that time, and for whatever reason and in whatever circumstances, there remains a continuing option to rescind all the contracts resulting from the lines written on a partially completed slip. This result was said to flow either from the implication of a term, as and when each line is written, which is necessary to give business efficacy to the resulting contract or, alternatively, from a binding usage or practice in the insurance market. In relation to the first of these pleas, the defendants were asked for particulars of the facts and matters relied upon in support of this allegation, and it is convenient to set out their answer: “If such terms were not implied- (1) a single contract of insurance would bind the several underwriters to different terms in the event that after some underwriters had initialled the slip (a) the assured failed to render terms to the other underwriters, or (b) the assured tendered a slip in different terms to the other underwriters, or (c) the other underwriters refused to initial the slip without an amendment or at all. (2) An assured would be compelled to accept and pay for incomplete cover in the event that it proved possible to start but not to complete the slip.” If one then turns back to the different situations listed under (a) to (g) above and to the report of the judgment of Staughton J [1982] QB 1022, 1037–1041, it will be seen that he accepted this conclusion — either on the basis of custom or of an implied term, or both — in all cases other than (c), ie where the slip has been fully subscribed and the insured or reinsured changes his mind thereafter. His conclusion in

relation to (c) was not challenged on this appeal, and it does not arise on the facts. However, there cannot in my view be any doubt about its correctness: see section 21 of the Marine Insurance Act 1906 and the two authorities referred to by Donaldson J in Jaglom’s case [1972] 2 QB 250 which Staughton J cites at pp 1031–1032. His conclusion as to (d) — the custom of writing down if the slip is subscribed to the extent of more than 100 per cent was also accepted as a matter of binding custom, and again there can be no doubt as to its correctness. However, in relation to all the other situations his conclusion as to the existence of an option of rescission was strongly challenged on this appeal, both by reference to implication and to usage. In particular, this conclusion was challenged in relation to (b), which corresponds most closely to the facts of the present case. Further and a fortiori it was challenged in situations which are not mentioned by the judge at all, but which relate directly to the present case, where a loss occurs before a slip is completed. In such cases, depending on the terms of the slip and the facts, the existence of an option would have the consequence that the underwriter of any line would or would not be held liable for his proportion of the loss depending on how the option is exercised. This is so in particular in the case of indorsement slips, as explained hereafter. I now turn to the facts against this background. They are fully set out in the report of the judgment at [1982] QB 1022, 1025–1031, but since the issues on this appeal are considerably narrower I can summarise them fairly shortly. I will refer to the first plaintiffs as “General Re” and to the defendants as “Fennia.” Fennia are insurers carrying on business in Finland and insured linerboard, sack kraft and pulp, ie paper products, in transit from Canada to Europe on a warehouse to warehouse basis. One of their customers was Eurocan Pulp Paper Co Ltd. Eurocan used four principal places of storage in Europe, one of these being a warehouse

in Antwerp. Fennia decided to reinsure their liabilities under this open cover, and did so in the first instance by a “whole account” reinsurance on all risk terms. In May 1976 this stood at FMks 12 million in excess of 3 million any one occurrence. (The figures are in Finnmark throughout; it appears from the judgment that the rate of exchange was from six to eight Finnmark to the pound sterling, so that the amounts involved are substantial.) The effect of this reinsurance was accordingly that Fennia would bear the first 3 million of any loss, the next 12 million would fall on the whole account reinsurers, and Fennia would again be liable for any excess. Fennia considered this to be inadequate, in particular for the risk of a catastrophic loss by fire or flood at one of the warehouses. They accordingly instructed their brokers, J K Buckenham Ltd, to place further facultative reinsurances on the London market against the risks of fire and flood at Eurocan’s four storage locations in Europe, including the warehouse in Antwerp, for 15 million in excess of 15 million any one occurrence, so that Fennia would be liable for the first 3 million and then only for any excess over 30 million. This reinsurance was written by means of a slip on which General Re were the leading underwriters, for 5 of the 15 million; the next was the Insurance Corporation of Ireland Ltd (“ICI”); and there followed 25 other reinsurers to complete the slip. Next, Fennia decided to increase the whole account cover as from 1 January 1977. Instead of 12 million in excess of 3 million it was altered to 20 million in excess of 5 million. There was therefore a partial overlap between the two reinsurances for losses due to fire or flood in the four locations, where the layer between 15 and 25 millions was doubly reinsured. At first this passed unnoticed, but when news of a fire at the Antwerp warehouse reached Fennia, on about 12 February 1977, though without appreciating its seriousness or relevance, they decided to rearrange the facultative cover retrospectively by placing it wholly on top

of the whole account cover as from 1 January 1977. A Mr Holmes, employed by the brokers, accordingly prepared an indorsement slip in the following terms: “It is understood and agreed that effective January 1, 1977, the sum reinsured hereon is amended to FMks 15,000,000 each and every loss, etc excess of FMks 25,000,000 each and every loss, etc. All other terms and conditions remain unaltered.” On 14 February 1977, Mr Holmes presented this slip to Mr Hollis, the manager of General Re’s London branch, who initialled it. Mr Holmes then took the slip to the ICI underwriter who also initialled it. However, the latter had by then already heard that the fire was serious, and this had by then also become clear to Mr Holmes and Fennia. Accordingly, after consultation between them, Mr Holmes was instructed not to proceed with the slip and to request General Re and ICI to cancel the amendment lines which they had written. At first both refused, but later ICI agreed, as the judge said at p 1029F, “on the very proper ground that they had known of the loss at Antwerp when their representative initialled the amendment slip.” Mr Hollis, however, maintained his refusal. He was understandably somewhat mystified, if not suspicious, about the indorsement slip generally, particularly since Mr Holmes was not asking for any return of premium although the amendment removed the reinsurers’ liability to a higher layer. However, all these matters were carefully investigated by the judge, and any suggestion of a material nondisclosure or other impropriety on the part of Fennia has disappeared from the case The only issue is whether Fennia were in law entitled to demand that Mr Hollis should cancel his line on the indorsement slip I now return to the fire at the Antwerp warehouse which took place on the night of 11–12 February 1977. This

destroyed paper stocks to a value of about 27 million. On the basis of the original slip without the amendment, the 27 London reinsurers were accordingly liable for 12 million in excess of 15 million. However, on the basis of the indorsement slip their liability would only have been 2 million. Although a writ was originally issued in the name of all 27 reinsurers, with General Re and ICI as the effective plaintiffs, ICI dropped out following their agreement to cancel their signature on the indorsement slip, and they and all the other reinsurers have settled with Fennia on the basis of the original slip. The issue now only concerns General Re, who claim a declaration that the line which they wrote on the amendment slip remains binding, so that their liability is only for their proportion of 2 million and not of 12 million. As against this, Fennia counterclaim General Re’s proportion of 12 million on the ground that they were entitled to cancel the uncompleted indorsement slip. In the result Staughton J refused the declaration and gave judgment for Fennia on the counterclaim on the ground that Fennia were entitled to exercise the alleged option of rescission. Before turning to the evidence and the judge’s reasoning, it is important to focus on the consequences flowing from the writing of a line on an indorsement slip in circumstances such as the present. It was written by General Re on 14 February 1977, with retrospective effect as from 1 January 1977. On this appeal, and for the reasons already explained, it was accepted by both sides that, when written, it resulted in a binding contract, subject only to the issue whether or not Fennia retained an option to rescind the contract thereafter. Under the terms of this line General Re were only liable on and after 1 January 1977, for their proportion of 15 million in excess of 25 million, ie of 2 million in relation to the loss by fire on 11–12 February. On the other hand, by purporting to exercise an option to rescind this contract, Fennia were accordingly increasing General Re’s liability very substantially, and this, of course, was the reason why

Mr Holmes was instructed to request cancellation of the amending line. However, consider for one moment what would have been the position if, instead of this rearrangement of the cover, the indorsement slip had provided for an increase in the cover to, say, 25 million in excess of 5 million on payment of an additional premium. I realise that this does not fit in with the “whole account” cover on the facts of the present case, but it is nevertheless necessary to consider such examples, because the legal position resulting from the alleged option would still apply in the same way. In that event the effect of General Re writing the line on the amendment slip would be, retrospectively to 1 January 1977, that their liability for a loss of 27 million would have been their proportion of 22 million, with the result that, obviously, Fennia would not have sought to exercise the alleged option of rescission. This example of what may, in particular, be the position in relation to indorsement slips, if there is an intervening loss before the slip has been fully subscribed, is of considerable importance when one comes to consider the evidence and the judge’s conclusions concerning the alleged custom and implied term. In the case of an original slip, if the loss is covered — though of course only partially — by a line which has already been written, the insured or reinsured will have no interest in exercising the alleged option of rescission. He will hold the subscriber to the contract resulting from the line, even though the intervention of the loss will in practice preclude him from procuring the completion of the slip on the same terms. This is precisely what happened in Morrison v Universal Marine Insurance Co, LR 8 Ex 40 and 197 to which I have already referred. In such cases no question of exercising any alleged option to rescind is ever likely to arise. However, in the case of uncompleted indorsement slips the position will be different according to whether the amending line increases or decreases the extent of the cover. In such cases, if the alleged option exists, the position

of the insured or reinsured can be summarised as “heads I win, tails you lose.” If the cover is increased, he will hold the underwriter to his line. But if it is decreased, as in the present case, he will seek to exercise the alleged option. When one then considers the evidence of the alleged custom which the judge found to exist in the present case, one finds in my view that none of the witnesses were directing their minds to these implications, because none of them had in mind the possibility of an intervening loss before the slip had been fully subscribed. In effect, their evidence was only directed to the following question in the context of original slips and not of indorsement slips: “If an insured or reinsured changes his mind before a slip has been fully subscribed, or if it becomes apparent that the broker cannot procure completion of the slip on its original terms from the other underwriters, because they decline to follow the leader and require some alteration in the terms of the cover, is there a right or option of rescission, by the custom or practice of the market, in relation to the lines already written, in particular if the risk has already incepted?” The judge answered this question in the affirmative in relation to original slips, and went on to hold that the same consequences also apply to indorsement slips despite the absence of any evidence of custom in this regard: see [1982] QB 1022, 1039–1041. However, with great respect, in my view no option or right of rescission of any kind, whether by custom or implication of law, has been established in the present case, let alone after the occurrence of a loss affecting lines previously written on an indorsement slip. In relation to original slips, I do not think that the evidence was sufficient to establish any binding custom, even within the limits of the question set down above. In relation to indorsement slips there was simply no evidence at all, and no reason to believe that the market would accept the full implications which would follow from the judge’s conclusion in this regard. [His lordship then

reviewed the evidence of the witnesses at the original trial on whether any binding custom existed.] …With the greatest respect to Staughton J, I cannot begin to accept that any of this evidence goes anywhere near to establish a binding custom entitling an insured or reinsured, as of right and at his unfettered option, to cancel the contract resulting from the writing of a line which — as everyone agreed — is immediately binding on the underwriter. No doubt such situations would in practice be readily resolved by agreement, possibly subject to any “time on risk” premium which may be due, if and when requests for cancellation are made. But this is a long way from proof of a legal right by custom. A fortiori it is clear that there was no evidence whatever to suggest the existence of any such custom in relation to indorsement slips, let alone after the occurrence of a loss which, depending on the terms of the slip, would place the insured or reinsured in the “heads I win, tails you lose” position to which I have referred. Accordingly, I cannot accept the judge’s conclusions concerning the allegation of a binding custom. One then comes finally to the alternative basis on which an optional right to cancel was said to rest, viz, implication of law. However, given the conclusion that no custom to this effect has been established, it would clearly be impossible to conclude that an unfettered option of cancellation arises by implication of law as a matter of necessary business efficacy. Any such implication would be unnecessary, since it was agreed on all sides that it is always open to a broker wishing to test the market without commitment to do so by circulating a “quotation slip.” Moreover, in the case of indorsement slips which, depending on their terms, would entitle the insured or reinsured to cancel or to hold the underwriter to his line in the face of a claim which has meanwhile arisen, the implication of any such option would

also be clearly unreasonable, since one party would be at the mercy of the other. For these reasons I am left in no doubt that this appeal must be allowed and that Fennia’s counterclaim for payment on the basis of the original unamended slip must be dismissed. They had no right to require cancellation of the line written by Mr Hollis on the indorsement slip. The declaration to the same effect claimed by General Re appears to follow, but we should hear counsel as to whether it is appropriate to make any order in this regard.’

Slade LJ: ‘I have had the advantage of reading in draft the judgment of Kerr LJ. I respectfully agree with all of it… No doubt underwriters who operate in the London insurance market will value the goodwill of brokers who operate in the same market. It is not surprising, therefore, that in the situation referred to by Staughton J [before the slip has been fully subscribed] underwriters who have subscribed a slip may not ordinarily in practice stand on their strict rights, but will, as a matter of grace, permit cancellation. There is, however, the world of difference between a course of conduct that is frequently, or even habitually, followed in a particular commercial community as a matter of grace and a course which is habitually followed, because it is considered that the parties concerned have a legally binding right to demand it. As Ungoed-Thomas J pointed out in Cunliffe-Owen v Teather & Greenwood [1967] 1 WLR 1421, 1438: “What is necessary is that for a practice to be a recognised usage it should be established as a practice having binding effect.” …With great respect to [Staughton J], I therefore think that the evidence did not suffice to support his finding that there is a custom and practice of the London insurance market which gives an assured a legally enforceable right of the nature referred to at the beginning of this judgment. A

fortiori, as Kerr LJ has said, it is clear that there was no evidence to suggest the existence of any such custom in relation to indorsement slips, let alone after the occurrence of a loss. On the question of an implied term, I have nothing to add to what Kerr LJ has said, with which I fully agree. For these reasons and the further reasons given by him, I agree that this appeal must be allowed.’

The view that each underwriter enters into a separate contract on subscribing to the slip means that each could negotiate new terms, however, the practice of the market seems usually to work in a way that removes the problems this might cause. [520] American Airlines Inc v Hope [1974] 2 Lloyd’s Rep 301 (HL) Lord Diplock: ‘Contracts of insurance are placed at Lloyd’s by a broker acting exclusively as agent for the assured. It is he who prepares the slip in which he indicates in the customary “shorthand” the cover that the assured requires. He takes the slip in the first instance to an underwriter whom he has selected to deal with as leading underwriter, ie, one who has a reputation in the market as an expert in the kind of cover required and whose lead is likely to be followed by other insurers in the market. If it is the first contract of insurance covering that risk in which a particular underwriter has acted as leading underwriter it is treated as an original insurance. The broker and the leading underwriter go through the slip together. They agree on any amendments to the broker’s draft and fix the premium. When agreement has been reached the leading underwriter

initials the slip for his proportion of the cover and the broker then takes the initialled slip round the market to other insurers who initial it for such proportion of the cover as each is willing to accept. For practical purposes all the negotiations about the terms of the insurance and the rate of premium are carried on between the broker and the leading underwriter alone. Where, as is often the case, the slip gives to the assured options to cover additional aircraft or additional risks during the period of the cover it does so on terms to be agreed with the leading underwriter. This is indicated by the abbreviation “tba L/U”. The slip contemplates its eventual replacement by a policy of insurance in the standard form in use at Lloyd’s for aviation risks, but subject to such deletions and additions as are indicated in the slip. Such additions are generally clauses which themselves follow a standard form and are sufficiently identified in the slip by a reference to a description or a number but some may be specially tailored to the particular requirements of the assured. In the latter case if the slip is for an original insurance the actual clause is set out in the slip itself, although it may be only in abbreviated form. After the slip has been initialled by all the insurers it is retained by the broker. In due course, often after several months, he prepares the policy from the slip. In the case of an original insurance he generally agrees the wording of the policy with the leading underwriter before taking it to Lloyd’s Policy Signing Office for signature. Almost invariably the slip provides that the wording of the policy is to be agreed by leading underwriter. Where this is the case the leading underwriter may occasionally consent to some clause going into the policy which was not provided for by the slip, if in his judgment it would not affect the premium. So there is the possibility of minor variations being made in the contract of insurance when the terms of the policy are agreed.’

6 The Doctrine of Insurable Interest in Property Insurance 6.1 Introduction Insurable interest is a prerequisite to recovery under a contract of insurance. It arises from the principle of indemnity and from a range of statutory provisions. The requirement is said to operate to distinguish insurance contracts from wagers. Prior to legislative intervention the general position at common law was that wagering contracts were enforceable — with the possible exception of fire insurance (see Sadler’s Co v Badcock (1743) 2 Atk 554) — and during the early eighteenth century it was the practice of marine insurers, for example, to underwrite risks without requiring the insured to demonstrate either ownership or some other legal interest in the ship or cargo to be insured. In essence these contracts were naked wagers on whether the vessel would successfully reach its destination. Although insurance was presumed to be a contract of indemnity, so that

only an insured with some interest which has been lost could recover, that presumption was rebutted by the use of phrases such as ‘interest or no interest’ in the contract. The prevalence of wagering which led to the statutory reforms extracted below is apparent from the commentaries of the time: [601] Thomas Mortimer, Every Man His Own Broker (London, WJ & J Richardson, 1801) ‘Insuring of property in any city or town that is besieged, is a common branch of gambling insurance in time of war; but ingenious gamesters, ever studious to invent new, and variegate old games, have, out of this lawful game, (for insurance in general is no more than a game of chances), contrived a new amusement for gentlemen…which is for one person to give another forty pounds, and if café Gibralter (for instance) is taken by a particular time, the person to whom the forty pounds are paid, is to repay £100; but if, on the contrary, the siege is raised before the time mentioned, he keeps the £40. In proportion as the danger the place is in of being taken increases, the premium of insurance advances; and when the place has been so situated, that repeated intelligence could be received of the progress of the siege, I have known the insurance to rise to £90 for one hundred… Of sham insurances…made on places besieged in time of war, foreign ministers residing with us have made considerable advantages. It was a well known fact, that a certain ambassador insured £30,000 on Minorca, in the war of 1755, with advices at the same time in his pocket that it was taken. Our government did not get the intelligence till two days after this transaction. It was the third before it was

made public; and thus the ambassador duped our people, who continued to accept premiums till the third day.’

A modern example illustrating an attempt to use insurance as a subterfuge for wagering is the Newbury International case: [602] Newbury International Ltd v Reliance National Insurance Co (UK) Ltd [1994] 1 Lloyd’s Rep 83 [The claimants, Newbury International Ltd, effected two policies to ‘indemnify’ them in respect of their contractual liability to pay £425,000 in the event of Russell Ingall, a well known racing driver, achieving a top three series position after the twelth race in the 1992–93 New Zealand International Formula Ford Series. In all matters relevant to the policy the claimants were represented by a Mr Graham Lorimer who, though not formally appointed a director of the claimant company, nevertheless managed its affairs]. Hobhouse J: ‘The substance of the matter which in my judgment emerges clearly from the evidence I have heard and read is that Newbury International never in truth had any insurable interest under either of these policies. They were merely a device by which Mr Graham Lorimer, through various of the companies that he represented or controlled, was seeking to raise money to finance a Formula 3 season in the United Kingdom in 1993. What he was doing was in substance placing bets upon Russell Ingall coming in the first three in the New Zealand Championship with the intention, when he won the bet, of using the proceeds in the way indicated…If

policies of prize indemnity insurance are to be valid contracts of insurance they must be a true liability to another which is the subject matter of the insurance.’

Note: As is apparent from the eighteenth and nineteenth century statutes extracted below (see particularly the Preamble to the 1745 Act and section 1 of the 1774 Act), wagering was viewed as an inherently evil practice and between 1745 and 1845 Parliament sought to address the societal waste it was perceived as causing. The legislation was directed towards prohibiting the enforcement of wagering agreements by requiring, for the purposes of insurance, an insurable interest. A further problem to which this requirement was directed was that posed by moral hazard namely, that an insured lacking insurable interest might succumb to the temptation of engineering the loss in order to gain from the proceeds of the policy. Put simply, the rationale is that if an insured is indemnified only to the extent of his or her interest in the insured property there is little or no incentive to bring about the loss in order to receive an insurance windfall. We consider the merits of this policy concern below. But for present purposes, the link between insurable interest and the principle of indemnity (see chapter 13) should be noted.

6.1.1 The Principal Legislation

(i) The Marine Insurance Act 1745 made insurable interest a prerequisite to the validity of a marine policy: [603] Marine Insurance Act 1745 (19 Geo II, c 37). ‘Preamble the making assurances, interest or no interest, or without further proof of interest than the policy, hath been productive of many pernicious practices, whereby great numbers of ships, with their cargoes, have either been fraudulently lost and destroyed, or taken by the enemy in time of war; and such assurances have encouraged the exportation of wool, and the carrying on many other prohibited and clandestine trades, which by means of such assurances have been concealed, and the parties concerned secured from loss, as well to the diminution of the publick revenue, as to the great detriment of fair traders: and by introducing a mischievous kind of gaming of wagering, under the pretence of assuring the risque on shipping, and fair trade, the institution and laudable design of making assurances, hath been perverted; and that which was intended for the encouragement of trade and navigation, has in many instances, become hurtful of, and destructive to the same.’

By section 1 all insurance contracts made on British ships and their cargoes are “null and void” where they are made ‘interest or no interest, free of average, and without benefit of salvage to the assurer.’ Such a policy was declared void even if the ‘insured’ did, in fact, possess an insurable interest.

The 1745 Act was repealed by the Marine Insurance Act 1906. [604] Marine Insurance Act 1906 (6 Edw 7 c 41) ‘4. Avoidance of wagering or gaming contracts (1) Every contract of marine insurance by way of gaming or wagering is void. (2) 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; (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.’

The Marine Insurance (Gambling Policies) Act 1909 (9 Edw 7, c12), section 1(1) goes on to provide that a person effecting a marine insurance without interest shall be guilty of an offence, and shall be liable, on summary conviction, to imprisonment. (ii) The second legislative intervention was directed towards making insurable interest a prerequisite to the validity of a life policy (see chapter 7) although, given the language of the Act, there is some doubt as to whether it applies to real property insurance (see below). You should note

that the stated objective of the statute is to address ‘mischievous’ gaming. [605] The Life Assurance Act 1774 (14 Geo III, c 48) ‘Preamble An Act for regulating Insurance upon Lives, and for prohibiting all such Insurances except in cases where the Persons insuring shall have an interest in the Life or Death of the Persons insured. 1. No insurance to be made on lives, etc, by persons having no interest, etc. Whereas it hath been found by experience that the making insurances on lives or other events wherein the assured shall have no interest hath introduced a mischievous kind of gaming: For remedy whereof, be it enacted by the King’s most excellent Majesty, by and with the advice and consent of the lords spiritual and temporal, the commons, in this present Parliament assembled, and by the authority of the same, that from and after the passing of this Act no insurance shall be made by any person or persons, bodies politick or corporate, on the life or lives of any person, or persons, or on any other event or events whatsoever, wherein the person or persons for whose use, benefit, or on whose account such policy or policies shall have not interest, or by way of gaming or wagering: and that every assurance made contrary to the true intent and meaning hereof shall be null and void to all intents and purposes whatsoever. 2. No policies on lives without inserting the names of persons interested, etc. And…it shall not be lawful to make any policy or policies on the life or lives of any

person or persons, or other event or events, without inserting in such policy or policies the person or persons name or names interested therein, or for whose use, benefit, or on whose account such policy is so made or underwrote.

(Section 2 was amended by section 50 of the Insurance Companies Amendment Act 1973: ‘50 (1) Section 2 of the Life Assurance Act 1774 (policy on life or lives or other event or events not valid unless name or names of assured etc. inserted when policy is made) shall not invalidate a policy for the benefit of unnamed persons from time to time falling within a specified class or description if the class or description is stated in the policy with sufficient particularity to make it possible to establish the identity of all persons who at any given time are entitled to benefit under the policy. (2) This section applies to policies effected before the passing of this Act as well as to policies effected thereafter.’) 3. How much may be recovered where the insured hath interest in lives. And…in all cases where the insured hath interest in such life or lives, event or events, no greater sum shall be recovered or received from the insurer or insurers than the amount of value of the interest of the insured in such life or lives, or other event or events. 4. Not to extend to insurances on ships, goods, etc. Provided always, that nothing herein contained shall extend or be construed to extend to insurances bona fide made by any person or persons on ships, goods, or mechandises, but every such insurance shall be as valid and effectual in the law as if this Act had not been made.’

Note: The construction of the Life Assurance Act 1774 was recently subjected to thorough analysis by the Court of Appeal in Feasey v Sun Life Assurance Co of Canada [2003] EWCA Civ 885, considered in chapter 7 (see [707] and [708]). (iii) The next major legislative response to wagering contracts was the Gaming Act 1845. Previous Gaming Acts sought only to regulate aspects of wagering, principally securities given for money lost: see, for example, the Gaming Act 1664 (16 Cha c 7) and the Gaming Act 1710 (9 Anne C19). The 1845 Act is directed towards a general prohibition of gaming contracts and applies to ‘goods and merchandises’ which, until the passing of this Act, continued to be enforceable without interest: [606] Gaming Act 1845 (8 & 9 Vict C109) ‘18 Contracts by way of gaming to be void, and wagers or sums deposited with stakeholders not to be recoverable at law; saving for subscriptions for prizes. …All contracts or agreements, whether by parole or in writing, by way of gaming or wagering, shall be null and void; and no suit shall be brought or maintained in any court of law or equity for recovering any sum of money or valuable thing alleged to be won upon any wager, or which shall have been deposited in the hands of any person to

abide the event on which any wager shall have been made….’

(The Marine Insurance Act 1788 requires that every policy on goods contain the name of a person interested in them. The 1788 Act was repealed by the Marine Insurance Act 1906 insofar as it applied to marine policies. It still technically applies to land policies on goods).

Notes: 1. While section 4 of the Life Assurance Act 1774 expressly excludes insurances of goods, such contracts are nevertheless caught by the 1845 Act. 2. Insurance effected in expectation of acquiring an interest will not be void provided such interest can be shown at the time of loss. Similarly, a policy will not be void where the insured has an insurable interest at the time of the contract but not at the time of loss. It is also noteworthy that a limited interest is sufficient to denude the agreement of any element of wagering. However, in such cases the indemnity principle operates to require the insured to hold insurance monies on trust for the owner, for example a bailor, to the extent that they exceed the value of the insured’s interest in the property (Waters v Monarch Life and Fire Assurance Co (1856) 5 El & Bl 870, (see below, [622]).

3. Although for fire insurance the common law required interest at the time of effecting the policy and at the time of the loss (Sadler’s Co v Badcock (1743) 2 Atk 554, Lord Chancellor Hardwicke), the current position is that for indemnity insurance the insured must possess insurable interest at the time of the loss if he or she is to recover under the policy. Indeed, it is fairly common to effect insurance before the subject matter has come into existence (eg crops). 4. In summary, the insurable interest doctrine represents a prophylactic response to insurance contracts being used as a subterfuge for wagering and the intentional destruction of property or life. Where insurable interest is lacking the contract is declared null and void by all the statutes extracted above ([604]–[606]) and, for the purposes of the Life Assurance Act 1774, illegal (see further chapter 7). It was commented above that it is unclear from the drafting of the Life Assurance Act 1774 whether it applies to real property insurance. As a consequence, the issue has been left to the courts to resolve and the caselaw is not entirely consistent: [607] Re King, Robinson v Gray [1963] Ch 459 (CA) [The facts are immaterial].

Lord Denning: ‘You must remember that when you take out a policy of fire insurance of a building (as distinct from goods), you must insert in the policy the names of all the persons interested therein, or for whose use or benefit it is made. No person can recover thereon unless he is named therein, and then only to the extent of his interest. That is clear from the Life Assurance Act 1774 (14 Geo 3, c 48), ss 2, 3, and 4, which by its very terms applies to “any other ‘event’ as well as life.”’

[608] Mark Rowlands Ltd v Berni Inns Ltd [1986] 1 QB 211 (CA) [The basement area of a building was leased by the plaintiff to the defendant. Due to the negligence of the defendant the whole building was destroyed by fire. The lease had provided that the claimant would insure the property and the defendant would contribute a sum amounting to approximately one quarter of the premium, this being a fair proportion of the entire insurance premium for covering the whole building against loss or damage. The defendant was relieved from the covenant to repair in respect of ‘damage by or in consequence of any insured risks.’ However, the defendant was not a party to the insurance. The insurer therefore argued that the defendant could not benefit from the fire insurance because it was not named in the policy as required by section 2 of the 1774 Act]. Kerr LJ: [cited section 2 of the 1774 Act]

‘Although obviously directed primarily to life insurance, the words ‘or other event or events’ admittedly widen its scope. A literal application of the language of section 2 would create havoc in much of our modern insurance law… In my view [counsel for the defendant] was right in his submission that this ancient statute was not intended to apply, and does not apply, to indemnity insurance, but only to insurances which provide for the payment of a specified sum upon the happening of an insured event. I think that this is supported by the long title of the Act, and in Halsbury’s Statutes of England, 3rd edn, vol 17 (1970), p 827, it is pointed out that this Act is also known as the Gambling Act 1774. In Dalby v India and London Life Assurance Co (1854) 15 CB 365, 387 [see chapter 7, [705]] the judgment of the court, delivered by Parke B., appears to distinguish insurances covered by this Act from indemnity insurance….’

[609] Siu Yin Kwan v Eastern Insurance Ltd [1994] 2 AC 199 (PC) [For the facts and another part of the judgment see below, [635]]. Lord Lloyd of Berwick: ‘They now turn to consider the second main defence, based on section 2 of the Life Assurance Act 1774. It can be dealt with quite shortly. Mr Thomas [counsel for the insurers] submits, and the majority of the Court of Appeal have held, that the policy is payable on the happening of an event, within the meaning of section 2 of the Act, that event being the insured’s liability to pay compensation in respect of injury to his employees. Since the name of the person interested, that is to say Axelson, was not inserted in the policy, the insurance is unlawful and void. The meaning of

section 2 of the Act was considered recently by the Court of Appeal in Mark Rowlands Ltd v Berni Inns Ltd [19861 QB 211, a case of fire insurance…The question was whether the policy taken out by the plaintiff enured for the benefit of the defendant, although his name did not, appear in the policy. It was held that the policy did not infringe section 2 of the Act, since the Act was not intended to apply to indemnity insurance…[Lord Lloyd cited Lord Denning’s judgment in In re King, decd (above, [607])]. Faced with this conflict of authority their Lordships prefer the decision of the Court of Appeal in the former case. In In re King, decd the point was not argued. The observation of Lord Denning MR was obiter and is not reflected in the judgments of the other two members of the court. Some doubt as to the correctness of Mark Rowlands Ltd v Berni Inns Ltd is expressed in MacGillivray and Parkington, p 155, para 154. But their Lordships do not share these doubts. There are two reasons why their Lordships prefer the decision in Mark Rowlands Ltd v Berni Inns Ltd. In the first place the words “event or events” in section 2, while apt to describe the loss of the vessel, are hardly apt to describe Axelson’s liability arising under the Employees’ Compensation Ordinance, or at common law, as a consequence of the loss of the vessel. Secondly, section 2 must take colour from the short title and preamble to section 1. By no stretch of the imagination could indemnity insurance be described as “a mischievous kind of gaming.” Their Lordships are entitled to give section 2 a meaning which corresponds with the obvious legislative intent.’

Notes: 1. Some jurisdictions have resolved the issue by amending the 1774 Act. In New South Wales, for example, the relevant statute (the Imperial

Acts Application Act 1969 (NSW)) excludes from the requirement of insurable interest: ‘insurance made by any person on ships or goods [and] contracts of indemnity against loss by fire or loss by other events whatsoever.’ 2. The Australian Law Reform Commission Report No 20, para 109 notes that ‘the effect of this exclusion would appear to be that, in New South Wales, the direct statutory requirement of insurable interest applies only to life, personal accident and other forms of nonindemnity insurance.’ It is to be hoped that similar measures will be taken in England so as to clear up the confusion surrounding the applicability of the 1774 Act.

6.2 Determining Insurable Interest Notwithstanding the critical importance of insurable interest to the validity of a policy, there is no consistent principle in common law jurisdictions governing its determination. The conventional definition is that an insured must possess some legal, equitable or contractual interest in the subject-matter of the policy (compendiously termed the legal interest test). Broadly speaking this means that an insured must have a proprietary interest in the insured property. However, most common law jurisdictions, notably Australia, Canada, New Zealand and the majority of US jurisdictions, have adopted the wider factual expectancy test whereby the

determinative question is whether or not the insured suffered some actual loss or detriment from the damage or destruction of the insured property, or stood to gain some advantage or benefit from its continued existence. Although the line of cases extracted below involved marine insurance, the views expressed by the various judges therein have been applied more generally to the definition of insurable interest. [610] Le Cras v Hughes (1782) 3 Dougl 79 [Sailors, commanded by a Captain Luttrell, and land forces captured an enemy Spanish ship ‘St Domingo’ together with its cargo. The Prize Act provided that captors of ships were entitled to be vested through proclamation by the Crown with rights to the seized property. The captain and crew insured the ship for the voyage back to England, during which it was destroyed due to the perils of the sea. The insurers refused the claim on the basis that the insureds lacked insurable interest. The insureds sued]. Lord Mansfield: ‘The defendants have set up a most unfavourable defence. At the time of the insurance being effected they were as well acquainted as Captain Luttrell with all the circumstances of the case; they knew that Captain Luttrell had no intention whatever of effecting a gaming policy, and yet they have not even offered to return the premium…The question, whether the sea-officers had an insurable interest, depends, 1. On the Prize Act and proclamation; or, 2. Putting the Act and proclamation out of the case, on the possession,

and on the expectation, warranted by almost universal practice. The first is the strongest ground, because it gives an interest, which will support an action. The whole that is taken is given to the Navy…If this be correct, there is an end of the question. But, 2. Is the expectation a sufficient interest? Wherever a capture has been made, since the Revolution, by sea or land, the Crown has made a grant: there is no instance to the contrary. Then, is the contingency of the ship’s coming home a risk the captors may provide against? It has been said that since the Statute of Geo 2 insurance is a contract of indemnity. An interest is necessary, but no particular kind of interest is required….’

[611] Boehm v Bell (1799) 8 TR 154 [The insureds had seized a ship as a prize. When the capture was adjudged unlawful by the Admiralty Court they sought to reclaim the premium on the basis that they lacked insurable interest in the vessel. They argued that the consideration upon which the premium was paid to the underwriters had failed because they lacked title to the vessel. Citing Le Cras v Hughes, the insurers contended that interest is not dependent upon possessing an absolute indefeasible title. A contingent interest is sufficient]. Grose, J: ‘This is a claim by the plaintiffs for a return of premium, on the ground that the assured had no insurable interest in the property. But it would be opening a source of infinite litigation, if we were to decide that this action could be maintained, and that a portion of the premium ought to be returned, in the event of its appearing that the assured had not an interest up to the extent of the insurance…With

regard to the [insurers contention], it seems to me that the whole difficulty has arisen from confounding an absolute indefeasible interest with an insurable interest. It is not pretended that the assured had the absolute property in the subject of insurance; neither need they have such property to make the policy legal; it is sufficient if they bad an insurable interest: and according to what was said by Lord Mansfield in the case of Le Cras v Hughes, they certainly had an insurable interest. If they had succeeded in the Court of Admiralty, it will be admitted that they had an insurable interest: and in case of their not succeeding there, there were events in which they might be made answerable, and against which it was competent to them to insure. I am therefore satisfied that they had an insurable interest in the subject insured; and this is a full answer to the present action.’

Lawrence J: ‘The case turns on this short question, whether or not the assured had an interest which they might insure? Did they mean to game? Or was not there a loss against which they might indemnify themselves, by a policy of insurance? I do not mean a certain, but a possible loss. Now, it has been shewn that this was a case in which the Court of Admiralty might have decreed them to pay damages and costs; and that is sufficient. It might be asked, in the language of Lord Mansfield, in Le Cras v Hughes, “Had not the insured such an interest in the ship coming home, as to entitle them to an indemnity?” I think that they had; and therefore that the plaintiffs are not entitled to a return of premium.’Postea to the defendant.

[612] Barclay v Cousins (1802) 2 East 545 [The facts appear from the judgment]

Lawrence J: ‘The case states that the insured shipped on board the ship “Jonah” a cargo of goods to be carried on a trading voyage; so that it appears that he had an interest in the profits to arise from a cargo which was liable to be affected by the perils insured against. And the question is, if on an insurance made on the profits to arise from such cargo can the plaintiff recover? As insurance is a contract of indemnity it cannot be said to be extended beyond what the design of such species of contract will embrace, if it be applied to protect men from those losses and disadvantages, which but for the perils insured against the assured would not suffer: and in every maritime adventure the adventurer is liable to be deprived not only of the thing immediately subjected to the perils insured against, but also of the advantages to arise from the arrival of those things at their destined port. If they do not arrive, his loss in such case is not merely that of his goods or other things exposed to the perils of navigation, but of the benefits which, were his money employed in an undertaking not subject to the perils, he might obtain without more risk than the capital itself would be liable to: and if when the capital is subject to the risks of maritime commerce it be allowable for the merchant to protect that by insuring it, why may he not protect those advantages he is in danger of losing by their being subjected to the same risks? It is surely not an improper encouragement of trade to provide that merchants in case of adverse fortune should not only not lose the principal adventure, but that that principal should not in consequence of such bad fortune be totally unproductive; and that men of small fortunes; should be encouraged to engage in commerce by their having the means of preserving their capitals entire, which would continually be lessened by the ordinary expenses of living, if there were no means of replacing that expenditure in case the returns of their adventures should fail. Where a capital is employed subject

to such risks, in case of loss the party is a sufferer by not having used his money in a way, which might with a moral certainty have made a return not only of his principal but of profit: and it is but playing with words to say that in such case there is no loss because there is no possession, and that it is but a disappointment. Foreign writers upon insurance, whose doctrines form the greatest part of our law on this subject, certainly do not treat of insurance on profits as a matter inconsistent with the true nature and design of such a contract; and where it is spoken of by them as a species of insurance which cannot be made, this latter doctrine will be found to be referable to the positive institutions of different nations, who have thought it wise to prohibit it…In this country there is no law forbidding such insurance, unless it could be shewn that the insurer had no interest in the profits, or that from its nature it must be a mere wager, so as to bring the case within the Stat 19 Geo 2. And that they are not considered as contracts inconsistent with the general nature of insurance is proved by the instance put of all insurance oil freight; which, as was very truly argued at the Bar, differs only from the case now before us in the same degree as a return of capital vested in shipping differs from a return of capital vested in merchandise; and by the cases Grant and Parkinson, in Marshall, 111, and Park 267, which was an insurance on the profits of a cargo of molasses; and the case of Henrickson and Walker, and Henrickson and Margetson, Mich 1776. The authority of Grant and Parkinson as applied to this case has been attempted to be gotten rid of by observing that the thing insured there was the profits of a specific cargo; but in that respect the two cases do not differ: for this is an insurance on a specific cargo; and we have no ground to say that the profits of a cargo to be exchanged in the African trade, from which exchange the profits will arise, are not, to use the expression of Lord Mansfield in Grant and Parkinson, pretty certain; admitting for the sake of the argument,

which it is not necessary for us now to determine, that in some mercantile adventures there may be so much uncertainty as to the profits, as to make it not possible to insure them without the policy being a wagering contract. This however we cannot presume of the returns to be made from an adventure undertaken according to a long established course of trade like that in question, in which numbers have been engaged to great advantage for a continued succession of years.’

Note: The leading case on the definition of insurable interest, and one which has shaped judicial thinking throughout Anglo-Commonwealth jurisdictions and the USA, is Lucena v Craufurd. [613] Lucena v Craufurd (1806) 2 Bos & Pul (NR) 269 [Commissioners had been given statutory authority to take charge of Dutch ships and cargoes in England. Acting under the orders of the Admiralty, a Royal Navy ship took several Dutch ships at sea. The commissioners then arranged to insure the ships while they were on their way to England. The ships were lost before they arrived. While the provisions of the legislation meant that the commissioners would clearly have had an insurable interest in the ships if they reached England, the issue was whether such an interest existed before the ships arrived. The case was first argued before Lord Kenyon CJ, the trial judge, and a special jury at the Guildhall in 1799; it

was then appealed to the Court of King’s Bench, the Exchequer Chamber, and finally reached the House of Lords in 1802. The majority of the judges in the Exchequer Chamber (Graham B, Rooke J, Thompson B, Hotham B, Macdonald CB, Lord Avanley CJ and Heath J) said: ‘an inchoate interest though imperfect till a given contingency shall have taken place is nevertheless insurable…It may be admitted that a mere hope or expectation cannot be insured, and it may therefore also be admitted that the next of kin to a person in a dying state and incapable of making a will, who has property on the sea, cannot insure that property…. Where nothing intervenes between the subject insured and the possession of it, but the perils insured against, the person so situated may insure the arrival of such subject of insurance, for he has an interest to avert the perils insured against…These commissioners had not a mere ideal expectation of probable interest, but an interest vested in them as trustees’ ((1802) 3 B & P 75).

In the House of Lords the majority of the judges called to give their advice (Le Blanc J, Grose J and Sir James Mansfield CJ took the same view as the majority in the Exchequer Chamber (in fact they were joined by judges that had already been of the majority in the lower court: Graham B, Rooke J, Heath J and Thompson B): ‘a vested interest is not necessary to give the right of insuring. The commissioners had a contingent interest; and supposing the intentions of the crown to remain unaltered, nothing stood between them and the vesting of that

contingent interest but the perils insured against…The question always is, whether the policy be a gaming contract? If it be no artifice how can it elude the force of the statute? The case of Le Cras v Hughes was infinitely more likely to introduce an abuse of the statute than the present case. That has been decided above 20 years; yet what ill consequences have followed? The same may be said of valued policies. In the case of wagering policies, any number of persons may make insurances on the same ship. But that is not the case here. If the commissioners could not insure this property, the Dutch owners could not; and it would be a strange paradox to assert, that these are ships and cargoes subject to all the perils of the sea in their voyage, and yet none are competent to insure them.’

In the House of Lords, two judges (Chambre J and Lawrence J) dissented from the advice offered by the majority and declared that there was no insurable interest. Chambre J (who had also dissented in the Exchequer Chamber), stated that the statute appointing the commissioners did not give them powers with regard to property until it arrived in the country, so that the only claim of interest was ‘a mere naked expectation of acquiring a trust or charge respecting the property without a scintilla of present right either absolute or contingent, in possession, reversion, or expectancy, in the proper legal sense of the word’].

Note: Lawrence J’s advice to the House of Lords and Lord Eldon LC’s speech, while reaching the same conclusion that the Commissioners lacked insurable

interest, contained what have become two competing tests for its determination. Lawrence J thought that a factual expectancy of interest was sufficient to demonstrate insurable interest while Lord Eldon preferred a narrower legal interest test. Lawrence J: ‘It is first to be considered what that interest is, the protection of which is the proper object of a policy of assurance. And this is to be collected from considering what is the nature of such contract…Mr Justice Blackstone in his Commentaries (v 2, 458), states it to be a contract between A and B upon A’s paying a premium equivalent to the hazard, B will indemnify or secure him against a particular event. These definitions by writers of different countries are in effect the same, and amount to this, that insurance is a contract by which the one party in consideration of a price paid to him adequate to the risk, becomes security to the other that he shall not suffer loss, damage, or prejudice by the happening of the perils specified to certain things which may be exposed to them. If this be the general nature of the contract of insurance, it follows that it is applicable to protect men against uncertain events which may in any wise be of disadvantage to them; not only those persons to whom positive loss may arise by such events, occasioning the deprivation of that which they may possess, but those also who in consequence of such events may have intercepted from them the advantage or profit, which but for such events they would acquire according to the ordinary and probable course of things. In the case of the loss of property it is obvious that the owner is prejudiced, and that therefore it is of importance to him, and he is concerned to avert the damage that it may be exposed to; in other cases there may be some difficulty in showing if the event had not happened, that those advantages would have arisen,

against the interception of by sea risks the assured means to be indemnified, but that difficulty when the nature of the contract is considered abstractedly does not prove that it must be confined to matters of property, where from the variety of probable contingencies (which independent of the specified risks may prevent the assured from deriving any benefit from the subject matter insured), it is impossible to weigh the probability of its being intercepted by such risks; an interest so uncertain may not be the subject of insurance…That a man must somehow or other be interested in the preservation of the subject-matter exposed to perils, follows from the nature of this contract, when not used as a mode of wager, but as applicable to the purposes for which it was originally introduced; but to confine it to the protection of the interest which arises out of property, is adding a restriction to the contract which does not arise out of its nature…A man is interested in a thing to whom advantage way arise or prejudice happen from the circumstances which may attend it…And whom it importeth, that its condition as to safety or other quality should continue: interest does not necessarily imply a right to the whole, or a part of a thing, nor necessarily and exclusively that which may be the subject of privation, but the having some relation to, or concern in the subject of the insurance, which relation or concern by the happening of the perils insured against may be so affected as to produce a damage, detriment, or prejudice to the person insuring and where a man is so circumstanced with respect to matters exposed to certain risks or dangers, as to have a moral certainty of advantage or benefit, but for those risks or dangers he may be said to be interested in the safety of the thing. To be interested in the preservation of a thing, is to be so cirumstanced with respect to it as to have benefit from its existence, prejudice from its destruction. The property of a thing and the interest deviseable from it may be very different: of the first the price is generally the measure, but

by interest in a thing every benefit and advantage arising out of or depending on such thing, may be considered as being comprehended…’

Notes: 1. Thus, in essence, for Lawrence J insurable interest is satisfied where the insured will be prejudiced by the loss of the subject-matter of the insurance while benefiting from its existence. 2. Lord Eldon LC delivered the principal speech in the House of Lords. His speech warrants careful reading because, as we shall see, the legal interest test formulated by him continues to generate controversy among judges and commentators alike. Lord Eldon: ‘The question is, Whether the power, or faculty, or right of concern and management which these commissioners might or might not have had, which they would have had if these ships had come into port, and which they might have ceased to have the moment after, be the subject of a legal insurance? Since the 19 Geo 2 it is clear that the insured must have an interest, whatever we understand by that term. In order to distinguish that intermediate thing between a strict right, or a right derived under a contract, and a mere expectation or hope, which has been termed an insurable interest, it has been said in many cases to be that which amounts to a moral certainty. I have in vain endeavoured however to find a fit definition of that which is between a certainty and an expectation; nor am I able to point out what is an interest unless it be a right in the

property, or a right derivable out of some contract about the property, which in either case may be lost upon some contingency affecting the possession or enjoyment of the party. In the 19 Geo 2, as well as in every other statute and charter relating to insurance, the objects of insurance are plainly described to be ships, cargoes, wares, merchandises, or effects. One or two later statutes mention property — but as to expectation of profits and some other species of interest which have been insured in later times, there is nothing to show that they were considered as insurable. I do not wish that certain decisions which have taken place since the 19 Geo 2 should be now disturbed, but considering the caution with which the Legislature has provided against gambling by insurances upon fanciful property, one should not wish to see the doctrines of those cases carried further, unless they can be shown to be bottomed in principles less exceptionable than they would be found to be upon closer investigation. Lord Kenyon, in Craufurd v Hunter, considered the 19 Geo 2 as a legislative declaration that an insurance might have been effected before that statute without interest. It is with great deference that I entertained doubts on that subject…. But whatever may have been the common law, the 19 Geo 2 has prescribed what should be the law thereafter, and all courts of justice are bound to follow up the spirit of that Act. If this power and faculty of future concern be an insurable interest, we ought at least to take care not to extend to such interest a protection that would be denied to policies of a more solid nature, lest that sort of wagering in policies should grow up, which has of late been extending itself considerably. It has been said, that the commissioners either are or are not like trustees, consignees, or agents, and that they had as good an insurable interest as the captors in the “Omoa” case, or a creditor on the life of his debtor. If the “Omoa” case was decided upon the expectation of a grant from the crown, I never can give my assent to such a doctrine. That

expectation, though founded upon the highest probability, was not interest, and it was equally not interest, whatever might have been the chances in favour of the expectation. That which was wholly in the crown, and which it was in the power of his majesty to give or withhold, could not belong to the captors, so as to create any right in them, I am far from saying, however, that that case might not have been put upon other ground. The captors not only had the possession, but a possession coupled with the liability to pay costs and charges if they had taken possession improperly. There was also a liability to render back property which should turn out to be neutral, and a liability as agents to act for the king as their principal; and I should be disposed to say, that the king had an insurable interest as the person who had jus possessionis. His right indeed was liable to be affected by a sentence of the Court of Admiralty. But as the insured is often entitled to consider the property as gone the moment the capture takes place, so I think that the king may be considered as against all the world as having an interest in the property before condemnation for the purpose of insuring. With respect to the case of a trustee, I can see nothing in this case which resembles it. A trustee has a legal interest in the thing, and may therefore insure. So a consignee has the power of selling, and the same may be said of an agent. I cannot agree to the doctrine said to be established in the courts below, that an agent may insure in respect of his lien upon a subsequent performance of his contract, nor can I advise your lordships to proceed without much more discussion upon authority of that kind. There are different sorts of consignees: some have a power to sell, manage, and dispose of the property, subject only to the rights of the consignor. Others have a mere naked right to take possession. I will not say that the latter may not insure, if they state the interest to be in their principal. But in the present case the commissioners do not insure in respect of any benefit to themselves, nor of any

benefit to the crown, or to any other person or persons stated on this record; they insure merely as commissioners, and if they have a right so to insure, it seems to me that any person who is directed to take goods into his warehouse may insure; and that there is nothing to prevent the West India Dock Company from insuring all the ships and goods which come to their docks. If moral certainty be a ground of insurable interest, there are hundreds, perhaps thousands, who would be entitled to insure. First the dock company, then the dock-master, then the warehouse-keeper, then the porter, then every other person who to a moral certainty would have ally thing to do with the property, and of course get something by it. Suppose A to be possessed of a ship limited to B, in case A dies without issue; that A has 20 children, the eldest of whom is 20 years of age; and B 90 years of age; it is a moral certainty that B will never come into possession, yet this is a clear interest. On the other hand, suppose the case of the heir at law of a man who has all estate worth 20,000l a year, who is 90 years of age; upon his death-bed intestate, and incapable from incurable lunacy of making a will, there is no man who will deny that such an heir at law has a moral certainty of succeeding to the estate; yet the law will not allow that he has any interest, or any thing more than a mere expectation…Courts of justice sit here to decide upon rights and interests in property; rights in property, or interest derived out of contracts about property. They do not sit here to decide upon things in speculation. Speculative profits are nothing. I send my ship to India; I expect profit from the voyage; if the ship is lost, my, expectation is defeated ; but of those expected profits the law can have no consideration…I cannot accede to that which has been stated as part of the doctrine upon this subject — that unascertained profits, which may or may not be made, may be insured. The present case, however, assumes not only that a man may insure unascertained profits from his own

losses, but that he may insure profits to arise out of ships and goods, which he has not, and which he never may have in his possession, and from the management of which he never can obtain any profit. If I were bound now to state my opinion judicially upon this first count, I should be obliged very strongly to say, that the claims of the plaintiffs could not be supported…’

Notes: 1. Lord Eldon’s legal interest test has received legislative endorsement. The Marine Insurance 1906, drafted by Chalmers as a codifying statute, replicates his formulation: Marine Insurance Act 1906 ‘5. Insurable interest defined (1) Subject to the provisions of this Act, every person has an insurable interest who is interested in a marine adventure. (2) In particular a person is interested in a marine adventure where he stands in any legal or equitable relation to the adventure or to any insurable property at risk therein, in consequence of which he may benefit by the safety or due arrival of insurable property, or may be prejudiced by its loss, or damage thereto, or by the detention thereof, or may incur liability in respect thereof.’

2.

Insurable interest spans the spectrum of ownership rights. While the obvious example is an absolute owner of property, others such as a remainderman whose interest is vested, a lessee and lessor, an adverse possessor, a mortgagor of land and a mortgagor of goods, possess sufficient rights in property to satisfy

the requirement. An equitable interest in goods or land such as that of a beneficiary under a trust, tenants in common, and joint tenants, will also suffice. A person with a limited interest in property may therefore possess insurable interest. This arises from the principle of indemnity (see chapter 13, below). Thus, bailees or carriers are able to effect valid insurance contracts on the property in their possession. Although they may insure the goods in question for their full value, the indemnity principle will limit the amount they can recover to a sum equal to their actual loss. Any excess will be held on trust for the third party owner (see Ebsworth v Alliance Marine Ins Co (1873) LR 8 CP 596, 629, per Bovill J). 3. A clear illustration of the legal interest test is afforded by Macaura v Northern Assurance Co Ltd — you should bear in mind that it is a fundamental principle of company law that a company is an entity distinct and separate from its members (see, Salomon v Salomon [1897] AC 22). [614] Macaura v Northern Assurance Co Ltd [1925] AC 619 (HL) [The insured, Macaura, was an unsecured creditor and the only shareholder in a limited company which owned a substantial quantity of timber, much of which was stored on his land. Two weeks after effecting insurance policies with several companies in

his own name, the timber was destroyed by fire. A claim brought by Macaura on the policies was disallowed on the ground that he lacked insurable interest in the timber]. Lord Buckmaster: ‘It must, in my opinion, be admitted that at first sight the facts suggest that there really was no person other than the plaintiff who was interested in the preservation of the timber. It is true that the timber was owned by the company, but practically the whole interest in the company was owned by the appellant. He would receive the benefit of any profit and on him would fall the burden of any loss. But the principles on which the decision of this case rests must be independent of the extent of the interest held. The appellant could only insure either as a creditor or as a shareholder in the company. And if he was not entitled in virtue of either of these rights he can acquire no better position by reason of the fact that he held both characters. As a, creditor his position appears to me quite incapable of supporting the claim…In the case of Moran, Galloway & Co v Uzielli [1905] 2 KB 555, where a creditor for ships’ necessaries was held entitled to insure the ship, the decision rested upon the fact that the creditor had a right in rem against the vessel, and the learned judge said that “in so far as the plaintiffs’ claim depends upon the fact that they were ordinary unsecured creditors of the shipowners for an ordinary unsecured debt, I am satisfied that it must fail. The probability that if the debtor’s ship should be lost he would be less able to pay his debts does not, in my judgment, give to the creditor any interest, legal or equitable, which is, dependent upon the safe arrival of the ship. This is, in my opinion, an accurate statement of the law, and the appellant therefore cannot establish his claim as creditor.”

Turning now to his position as shareholder, this must be independent of the extent of his share interest. If he were entitled to insure holding all the shares in the company, each shareholder would be equally entitled, if the shares were all in separate hands. Now, no shareholder has any right to any item of property owned by the company, for he has no legal or equitable interest therein. He is entitled to a share in the profits while the company continues to carry on business and a share in the distribution of the surplus assets when the company is wound up. If he were at liberty to effect an insurance against loss by fire of any item of the company’s property, the extent of his insurable interest could only be measured by determining the extent to which his share in the ultimate distribution would be diminished by the loss of the asset — a calculation almost impossible to make. There is no means by which such an interest can be definitely measured and no standard which can be fixed of the loss against which the contract of insurance could be regarded as an indemnity. This difficulty was realised by counsel for the appellant, who really based his case upon the contention that such a claim was recognised by authority and depended upon the proper application of the definition of insurable interest given by Lawrence J in Lucena v Craufurd. I agree with the comment of Andrews LJ upon this case. I find equally with him a difficulty in understanding how a moral certainty can be so defined as to render it an essential part of a definite legal proposition. In the present case, though it might be regarded as a moral certainty that the appellant would suffer loss if the timber which constituted the sole asset of the company were destroyed by fire, this moral certainty becomes dissipated and lost if the asset be regarded as only one in an innumerable number of items in a company’s assets and the shareholding interest be spread over a large number of individual shareholders. The authorities which have the closest relation to the present are those of Paterson v Harris

1 B & S 336 and Wilson v Jones L R 1 Ex 193; L R 2 Ex 139. In the first of these cases a shareholder in a company that was established for the purpose of laying down a submarine cable between the United Kingdom and America, effected an insurance upon his interest in the cable. The shareholder’s insurable interest in the cable does not appear to have been disputed and the real question, therefore, was never argued. In the case of Wilson v Jones where another policy was effected by a shareholder in the same company, it was distinctly held that the policy was not upon the cable but upon the shareholder’s interest in the adventure of the cable being successfully laid. It was attempted by the underwriters to limit the insurance to an interest in the cable itself, which would have lessened the risk, but it was held that this was not the true construction of the policy. It was not argued that, if it were, the shareholder had no interest to insure, but both Martin B in the Court of Exchequer and Willes J in the Exchequer Chamber, stated that the plaintiff had no direct interest in the cable as a shareholder in the company, and, so far as I can see, this consideration it was that assisted the Court in determining that the insurance was upon the adventure in which the shareholder had an interest, and not upon the cable in which he had none. There are no other cases that even approximately approach the present case, and, properly regarded, I think the case of Wilson v Jones is against and not in favour of the appellant’s contention. Upon the merits of this dispute, therefore, the appellant must fail. Neither a simple creditor nor a shareholder in a company has any insurable interest in a particular asset which the company holds. Nor can his claim to insure be supported on the ground that he was a bailee of the timber, for in fact he owed no duty whatever to the company in respect of the safe custody of the goods; he had merely permitted their remaining upon his land.’

Lord Sumner: ‘My Lords, this appeal relates to an insurance on goods against loss by fire. It is clear that the appellant had no insurable interest in the timber described. It was not his. It belonged to the Irish Canadian Sawmills, Ltd, of Skibbereen, Co Cork. He had no lien or security over it and, though it lay on his land by his permission, he had no responsibility to its owner for its safety, nor was it there under any contract that enabled him to hold it for his debt. He owned almost all the shares in the company, and the company owed him a good deal of money, but, neither as creditor nor as shareholder, could he insure the company’s assets. The debt was not exposed to fire nor were the shares, and the fact that he was virtually the company’s only creditor, while the timber was its only asset, seems to me to make no difference. He stood in no “legal or equitable relation to “the timber at all. He had no “concern in” the subject insured. His relation was to the company, not to its goods, and after the fire he was directly prejudiced by the paucity of the company’s assets, not by the fire.’

Note: As commented above, the legal interest test has attracted substantial criticism by both judges and commentators in major common law jurisdictions. The article by Harnett and Thornton (below, [615]) was particularly influential in leading the Supreme Court of Canada (see below, [616]) to reject Lord Eldon’s approach in favour of Lawrence J’s factual expectation test. [615] Bertram Harnett and John V Thornton, ‘Insurable Interest in Property: A Socio-

Economic Reevaluation of Concept’ (1948) 48 Col LR 1162

a

Legal

[Footnotes in the original have been omitted]. (I) INTRODUCTION ‘With the ever-growing economic interdependence of individuals and nations, there exists a concomitant tendency for law and economics continually to gravitate closer and closer together. Particularly manifest is this trend in the insurance field. The creation and enforcement of insurance contracts impinge at every turn upon the public interest and vitally affect the social and economic welfare of individuals… The requirement of insurable interest in property insurance, like most legal abstractions, has developed over the centuries primarily through judicial resolution of relatively isolated problems. Seldom have the courts examined the entire picture in terms of meaningful underlying policies, and the myopic views of older cases, canonised by precedent, often reflect themselves too brightly in later years to the detriment of sound modem analysis. Since the insurable interest question is a phase of the insurance problem which intimately concerns the buyer, the trade, the home office counsel, the specialist, and the general legal practitioner, it is the very warp and woof of the enforceability of insurance contracts. Without the prerequisite of insurable interest, the contract is unequivocally unenforceable. No conduct on the part of the insurer, verbal or non-verbal, can be relied upon to constitute a waiver or an estoppel to assert the defect. To further illustrate the strong public policy enunciated in this requirement, it is only necessary to realise that the incontestability clause typically found in life insurance

contracts does not operate as a bar to a defence rooted in the lack of insurable interest. The defence is similarly available, notwithstanding the fact that the policy sued on is in a valued form. Because the business of insurance is at the very nucleus of the modern commercial economy, and because the general public is a gigantic daily consumer of the insurance product, a legal requirement which permits the insurer’s escape from contractual liability in such sweeping terms must be constantly reevaluated for utility and correspondence to social and economic practices and expectations. In defining insurance interest, it is most helpful to define the words individually, and then taken together. Insurance properly viewed is a contract: “whereby one party…is obligated to confer benefits of pecuniary value upon another party…dependent upon the happening of a fortuitous event in which the insured or beneficiary has, or is expected to have at the time of such happening, a material interest which will be adversely affected by the happening of such event [NY Ins Law § 41].” Interest is traditionally defined in terms of rights in the insured property, but it may also be characterised as such a relationship to property as makes a happening adversely affecting the insured property economically disadvantageous to the interest-holder. Insurable interest, then, is that kind of relationship to an occurrence, or, traditionally viewed, that kind of interest in the property insured, which a claimant must show in order to have a legally enforceable claim to recovery. As to when insurable interest must exist, there is a sharp conflict of authority. Some jurisdictions require the insurable interest to exist both at the inception of the policy and at the time of the loss. Many others hold the presence of the insurable interest

at the time of loss sufficient, merely demanding entire good faith in the insured at the inception. The objective of this study is to restate generally the types of insurable interests which have merited judicial recognition, followed by a critical analysis of the three policies supposedly underlying this sui generis requirement. These three policies are the policy against wagering, the policy against rewarding and thereby tempting the destruction of property, and the policy of confining insurance contracts to indemity. Upon the report of observed judicial conduct, and the analysis of the purposes of the requirement, a reevaluation of the entire concept will be set forth.

(II) THEORY VERSUS PRACTICE: THE INSURABLE INTEREST CONCEPT AS A WORKING TOOL A) Generic regrouping of conventional insurable interest categorisations… The range of interests embraced within the category “insurable” is not co-extensive with the law of property interests generally, but rather includes property interests and runs indeterminately beyond…As seen through the eyes of modern courts, the insurable interest concept possesses four main heads. The first and broadest heading embraces property rights, whether legal or equitable. The second and closely allied category includes those types of interests which are reflected in contract rights. The possibility of legal liability as a result of the insured event is the third division while the fourth is the controversial residuum category of “factual expectation of damage.” (1) Property right. In the law of insurable interest, an interest, operationally considered, is such a relation to property that an adverse occurrence may result in economic disadvantage upon the happening. In the usual course of events, the absolute owner of a unit of property is the

individual most likely to suffer economically from its destruction…It is not too much to say that the judicial quest for an incident of ownership is the largest factor to be considered in any discussion of insurable interest, whether the purpose be restatement, reevaluation, or reform. Thus it is that to courts, thinking in terms of property interests, insurable interest contains a distinct in rem connotation in the sense that the insured is required to have an enforceable interest in the res the destruction of which constitutes the insured event. A very common formulation of the property right grouping is in the terms, “an interest that would be recognised and protected by the courts.” This in essence is the conception of a property interest in the thing insured; the test seemingly is whether a court would enforce the interest in the property if the question should arise in an ownership controversy. Absolute ownership is the solid predictable foundation of this unsteady insurable interest structure that has often been constructed with the mortar of property concepts. However, every property interest is manifestly not absolute ownership of a physical property unit, and as this interest fades into less than absolute ownership, the courts follow the recession and allow insurability. Ultimately the property right required to constitute an insurable interest narrows to the thinnest of threads. The ownership concept, for classification purposes, serves well to categorise those insurable interests which are estates in land and personality. While holders of these estates are the persons most likely to seek property insurance, it must always be borne in mind that property interests such as theirs are not the only ones acceptable to the courts. Qualified property interests such as those of life tenants, remaindermen, reversioners, lessors, and lessees are sufficient to be insurable interests… Equitable interests in property which will be protected or enforced by the courts are widely held to be insurable

interests. These include the interest of a vendee under an executory contract to sell land, a mortgagor holding an equity of redemption, and a beneficiary of a trust. It is also held that one of multiple owners of property possesses an insurable interest in his own right, as in such relationships as partners, shareholders or corporations, joint tenants, tenants in common, and spouses in community property jurisdictions. omestead rights likewise give rise to insurable interest. Pressing further on into the field of more shadowy property interests, it is discovered that generally a holder of the property itself or of legal title in representative, trust, or bailment relationship is held to have an insurable interest. Of course, the insurance proceeds paid on the destruction of the res inure to others where the policyholder himself has no beneficial interest in the property. This classification encompasses executors and administrators, trustees, and bailees. In the same way, receivers and trustees in bankruptcy probably have insurable interests for the benefit of creditors. Broadly summarised, then, ownership of all or part of a property unit, whether it be traditionally denominated legal or equitable, is regarded as sufficient to constitute an insurable interest. However, ownership of a physical allocation of property is not strictly necessary to come within the property right conception. As indicated above, the main factor in the property right category is the essentially in rem theme of enforceable rights in a specific res. In the nature of the modern commercial economy the security device occupies a prominent niche, and these security devices typically do provide the creditor with enforceable rights in a specific res. Therefore, the courts have recognised the insurability of the interest of lienors and secured creditors, as well as that of their debtors. Thus, it is that mortgagor and mortgagee, pledgor and pledgee, conditional vendor and conditional vendee, all have

insurable interests. Similarly, lienors holding mechanics’ liens or artisans’ liens, and judgment creditors with statutory liens have insurable interests. A vendor who has contracted to sell realty also has an insurable interest so long as he retains legal title or a lien on the property… (2) Contract rights…the contract right may conceivably be an insurable interest, even though there are no rights specifically in the insured property…The problem then is to develop a working guide for determining just what interrelation between contract performance and existence of the property insured suffices to constitute compliance with the requirement of insurable interest. There are few cases allowing an insurable interest based on contract right without property right. Generalisation is difficult, but a rule may be stated in these terms: a contracting party whose contractual rights are directly contingent on the continued existence of a property unit has sufficient insurable interest to recover on a policy of insurance, the insured event of which is damage to, or destruction of, that property unit. This rule covers a contract situation in which the contractual rights are conditioned on the continued existence of the property, either expressly or by implication. In the case of the unsecured simple contract creditor, generally the contract does not depend on the existence of any particular piece of the debtor’s property, and evidently this distinction, while questionable on closer analysis, is relied upon by the courts in denying insurable interest in that situation. In one case, the insured held a royalty contract under which payment to him was based upon a percentage of the monetary value of the total output of an oil refinery. He was adjudged to have an insurable interest in the oil refinery premises, and was allowed to recover on a policy of fire insurance which insured him against diminution of royalties. In another action, an insured who entered into a long term contract to operate a factory was held to have an insurable

interest in the equipment of that factory. In still a third case, a buyer insured a cargo of sugar being shipped to him in the United States from the Phillipines Islands. The contract specified “no arrival, no sale,” and although title did not pass from the seller, the court allowed the buyer an insurable interest in the sugar while in transit. In a sense, the contract right classification might well be included in the property right concept, for it represents a category of rights which the courts will enforce. However, it seems to belong in a distinct analytical grouping inasmuch as judicial concern here is not so much with an ownership or security interest in a res as it is with a relationship of economic disadvantage flowing from the insured event, with such relationship originating ex contractu. (3) Legal liability. Often times, fortuitous damage to a property unit will result in some form of legal liability on the part of one individual to another. If the occurrence of an insured event will cause an individual economic disadvantage in the form of legal liability, courts have tended to find an insurable interest in that happening. The policy of liability insurance itself is to be distinguished, however, from legal liability as an insurable interest in property. In liability insurance, the coverage does not attach to the destruction of an insured physical property unit, but rather the policy amounts to an assurance that the insurance carrier will provide financial protection from personal liability which might accrue to the insured. Thus, in liability insurance, an individual has unlimited interest in his own personal liability. The majority of the cases in which a potential legal liability engendered by destruction of the insured subject matter is held sufficient to establish an insurable interest has involved a liability accruing primarily through contract. It is familiar law that, in the absence of contractual stipulation, a builder stands the loss arising from fortuitous destruction of a building in the course of construction. Since

the builder is legally liable to the owner for the completion of the contract, he has an insurable interest which is sufficient to support a “builder’s risk” policy covering the premises while under construction. Similarly, a bailee who agrees contractually to insure the bailor’s interest in the bailed property has an insurable interest, and he may insure the property in his own name. A guarantor of a secured obligation, if held liable, would be subrogated to the lien against the secured property, and so he has been held to have an insurable interest in that property. The possibilities, however, are not limited to contract situations. An innocent convertor, under some circumstances, may be liable to a rightful owner, and his insurable interest in the converted chattel has been recognised. (4) Factual expectation of damage. This fourth conception, the so-called factual expectation of damage, is broad enough to occupy the entire field of juridical inquiry into the existence of insurable interest. However, despite early entry into the common law of insurance, this concept has enjoyed but uncertain recognition by the courts even to this modern day. The factual expectation is the simplest expressed, yet most all inclusive of the insurable interest concepts; it is the expectation of economic advantage if the insured property continued to exist, or, stated negatively, the expectation of economic disadvantage accruing upon damage to the insured property. The origin of the factual expectation concept may perhaps be traced to Lord Mansfield’s equivocal opinion in Le Cras v Hughes [above, [610]]. However, it is first clearly set forth by Lawrence J in Lucena v Craufurd [above, [613]]: “…it is applicable to protect men against uncertain events which may in any wise be of disadvantage to them.” In that case, Lord Eldon, writing another opinion laying down the requirement of legally enforceable interest in the property, said: “That expectation though founded on the highest probability, was not interest…” As indicated previously, Lord

Eldon’s strict formulation has become classical in the law, and the result has been an undue emphasis on property interests in the thing insured. In the overwhelming majority of the cases, judicial reasoning proceeds on the premise that a legally enforceable right is the measure of insurable interest. Nevertheless, factual expectation, a divergent concept, has had some judicial currency. A complicating factor is the wide circulation given factual expectation language through the media of several widely cited treatises and encyclopaedias. Many courts adopt these quotations in toto and give the impression that factual expectation as an insurable interest is settled law. Actually, most of the cases with liberal sprinklings of factual expectation language involve situations where actual property rights exist in the insured. Actions often belie words, for while a court may speak benevolently of the factual expectation in a case where there is already a property interest, later the same court will deny recovery to another claimant without property interest but with a factual expectation of damage. In the limited area in which factual expectations have gained recognition there have been a few recurrent situations where more realistic courts have allowed the interest. A favourite situation involves a possessor or operator of real property who has no judicially enforceable property right. In Liverpool & London & Globe Insurance Co v Bolling 176 Va 182 (1940), a land, and building owner allowed his former daughter-in-law to occupy the property rent free and to operate it as a business. There was some showing of intention on the part of the owner to convey a fee simple to the woman later, but no promise enforceable in equity appears. On destruction of the property by fire, the court allowed her a fee simple measure of recovery. Citing many of the widely circulated factual expectation quotations, the court clearly puts the interest in terms if

deriving economic support from the productivity of the premises… It is apparent that the factual expectation concept is, if applied, inclusive of all the concepts of insurable interest. In reality, the factual expectation concept is the true definition of insurable interest, phrasing insurable interest strictly in terms of a relationship to property such that the destruction of the property results in economic disadvantage, and recognising technical property interests as merely particular types of this relationship…

(III) POLICY CONSIDERATIONS UNDERLYING THE INSURABLE INTEREST CONCEPT (A) The policy against wagering under the guise of insurance 1. Analysis of the policy. The policy against enforcement of wagering contracts was developed in England primarily, through the legislative rather than the judicial process. The common law courts tolerated wagers, and it was only by a series of statutes culminating in the Gaming Act of 1845 that all wagering contracts came to be considered anathema. With the English experience as a background, it was not unusual that, in the main, American jurisdictions early condemned wagering agreements as contrary to their common law policy… On the social level the wager’s activities are essentially unproductive, for when one wagerer gains, another loses. Since an extension of his activities would disqualify the wagerer for other work and since he contributes nothing to society, the wagerer is anti-social in a subtle sense. His gambling transactions, tending as they do to increase the unequal distribution of wealth, result in a net loss to society… 2. Wagering and Insurance Differentiated. It is not the purpose of this article to take a stand in the controversy as

to the validity of the policy against wagering. Assuming the validity of that policy, it is, however, pertinent to inquire as to the relationship between wagering and insurance, in order that evaluation may be made of the extent to which the policy against wagering should be carried over into insurance law. While a perfectly fair wager is demonstrably unsound from the purely economic viewpoint, the insurance contract is not unsound, and in fact produces a net gain to society. Assume that X procures a $5,000 policy of fire insurance for a premium of $50. Further assume ideally fair conditions such that the chance of the destruction by fire of the $5,000 worth of property is one in one hundred. The bargain is then sound, because the $5,000 X may lose by fire represents a greater loss in terms of sacrifice in marginal utilitarian terms than one hundred times the loss of the $50 required to pay the premium. It is also clear that the sociological arguments against gambling have in general little bearing on insurance. There is no anti-social aspect to insurance, for it is not a matter of one losing and the other gaining; rather do both gain. The insured is fortified by the knowledge of the security of his economic expectations, enjoying quiet reliance, and the successful insurer reaps a profit which, unlike that of the typical gambler, is invested for socially beneficial purposes. The criminal and domestically disruptive aspects of gambling are not at all in evidence in insurance contracts. Property insurance is not commonly contemplated as a wagering transaction; if a wager is desired, far more usual and convenient devices are available with far greater chance of fortuitous success. It should not be supposed, however, that there is no gambling aspect to insurance. Where the insured has no valuable relationship to the property or where the insurance is in excess of the insured’s interest, that is, “whenever there is no genuine risk to be hedged,” the evils of wagering

in part reappear. Thus, while the requirement of an insurable interest in the form of some valuable relationship to the occurrence insured against does have validity, the prime danger to be avoided policywise is the equating of the economically necessary “insurable interest” with the legal categories customarily embraced within that term. While some form of valuable relationship to the occurrence is necessary to avoid the wagering aspect, the policy against wagering is satisfied by any valuable relationship which equals the pecuniary value of the insurance, regardless of the legal nature of that relationship. (B) The policy to Prevent Temptation to Destroy the Insured Property The theory behind this policy is simple: if the insured has no “interest” in the subject matter of the insurance, he is likely to destroy the subject matter in order to gain the benefit of the insurance. It is believed that closer analysis of this policy will reveal that the dangers envisioned by it are more fanciful than real. An important consideration striking at the validity of the temptation argument is the fact that in numerous instances the presence of an insurable interest not only does not minimise the alleged temptation but actually increases it. What of the impecunious fee simple owner the market value of whose property has in an economic depression declined beneath the level of his insurance coverage? Knowing his recovery will be the replacement value or perhaps a fixed valuation, will not this owner, although he has the greatest possible insurable interest — the fee simple, yet be tempted? What of the life tenant whose recovery is measured by the value of the fee simple interest? Will not he, despite his universally “insurable interest”, be tempted to destroy the property? Furthermore, it is believed that the minimisation of temptation allegedly produced by the requirement of insurable interest is completely neutralised by the fact that

the presence of an insurable interest ordinarily gives the greatest assurance that destruction of the subject matter can be effectuated without detection. Assume that X, an individual of criminal mind, seeks to defraud an insurance company. Assume further that the requirement of insurable interest does not exist in his state. Can any one reasonably suppose that X will insure Building A, in which he has no property interest, burn it down, and then seek to collect the insurance? This is unlikely because his collection of proceeds on the loss would be probative of his criminal guilt, and the criminal law serves as a deterrent force against such conduct. Likewise, the watchfulness of the insurer who stands to lose by destruction of the property serves as an assurance that policies will not be recklessly issued to throngs of wrongdoers. Typically, X, as a reasonably prudent criminal will burn down his own property which he has overinsured. Since the property is his own, he can systematically plan the fraud and carry it out, undisturbed by prying eyes, and leaving a minimum of evidence — things he could do only with great difficulty were the property in the control of another. Therefore, it is unrealistic to assume that the requirement of insurable interest minimises temptation; it may well in fact increase it. The requirement is based on theoretical considerations viewed in vacuo rather than in terms of social facts. (C) The Policy Favouring Limitation of Indemnity The traditional view of the insurance contract is that it is one of indemnity against loss. This view is in accord with the layman’s notion of insurance. Typically, the layman takes out insurance not for any wagering purpose but to assure himself of financial protection in the event of the subject matter of the insurance is destroyed. But what is behind the policy of insurable interest as a limitation on indemnity? Is it a separate and independent policy consideration in addition to those policies against

wagering and against the promotion of temptation to destruction? It is submitted that it is not in any sense an independent policy, but merely another head of the hydra that is the policy against wagering. To the extent that a possible insurance recovery is in excess of the insured’s interest, it is a wager, and limiting indemnity to the extent of the interest is simply the way in which an insurance contract is removed from the wager category. The traditionally distinct purpose of insurable interest as a limitation on indemnity is, then, merely the wagering policy accoutered in different verbal cloth.

(IV) REEVALUATION: SOCIO-ECONOMIC UTILITY AND THE LEGAL CONCEPT A realistic analysis of the purposes of the requirement of insurable interest yields the conclusion that the strong public policy against the enforceability of wagering contracts is at the base of the concept. While the general policy to discourage destruction of property has moral soundness and laudable social purpose, it is improperly associated with insurable interest. The historic notion that insurance is a contract of indemnity is doubtless true both in the contemplation of society and in the typical motivation for procuring an insurance policy, but as related to insurable interest it is merely another manifestation of the antagonism to the wager. Procurement of a policy of insurance is an investment prompted by commercial foresight. This foresight involves a recognition of a desirable economic relationship to a thing capable of destruction or damage, and the prudence of allocating certain monetary sums to insure financial protection in the event of a catastrophic occurrence. While in a broad semantic sense all insurance contracts are wagers, the notion has developed in the law that if there is an interest in the subject matter of the insurance,

independent of the occurrence of the insured event, then there is no wager. The qualification of interest independent of the happening of the occurrence is necessary because any wagerer has an economic interest in the happening of the wagered occurrence, that is, either winning or losing the stakes… If a policyholder has absolutely no relation to the property insured in any conceivable except that its destruction will inure to his benefit because he has staked money on that contingency, it is clearly a wager and not a bona fide commercial risk to be shifted. If the policy-holder is the sole and unconditional owner of unencumbered property, his insurance policy is patently a legitimate exercise of economic foresight, a shifting of a risk which will be regarded as an investment, not as a wager. But between the wagerer and the absolute owner is situated a vast assortment of persons, standing in various relationships to the property insured. Through this mass, the men of the law have drawn a line, and those who find themselves in the company of the wagerer on his side of the line are damned as wagerers themselves and denied the right to enter into an enforceable contract of insurance. The distressing factor in this picture is that the assemblage on the wagering side of the line contains relatively few sinister individuals of the popular gambler stereotype, for most are productive law abiding citizens who have freely paid insurance premiums in prosecution of the traditional freedom of contract. These latter “wagerers” are drawn from diffused economic segments; they are unsecured creditors, occupiers of land, spouses and others anticipating a factual expectation of damage from the insured event. Based on economic analysis it is submitted that there is only one true concept of insurable interest, and that is the factual expectation of damage. Restated, this conception is that insurable interest exists if the insured, independently of the policy of insurance, will gain economic advantage from

the continued existence of the insured property. The property right conception is…more accurately a grouping of individuals who are most likely to suffer damage; their factual expectation is high…

(V) CONCLUSION The law of insurable interest in property is entangled in considerations of the general policy against wagering. While the early English underwriters, particularly of life and marine risks, presented the courts with many invidious wagering transactions, the wager is clearly exaggerated in modern property insurance contemplation. Property insurance is procured almost universally by those seeking indemnification; the wagerer finds the cold precision of the calculated premium and the actuarial computation less attractive a gaming board than more conventional gambling devices. The question of an intended wager rarely arises; typically, the insured thinks he is exercising legitimate commercial foresight, only to discover upon later judicial analysis that he is a wagerer. Since men unlearned in the law regard their insurance policies as instruments of security and assurance, it is a grievous sociological error on the part of the judicial fraternity to allow insurance policy obligations to flake away mysteriously, and to prevent the procurement of insurance policies by interested parties who do not own traditional property rights. There must be a true perception of property right concepts in insurable interests, and a thorough recognition that “insurable interest” implies merely a relationship to a property unit that will lead to economic disadvantage if the property unit is impaired. The insurance carrier serves a valuable function in society, that of shifting economic risks. His service as indemnitor should not be limited to a judicially approved panel, but should extend to all the members of society who possess economic

relationships confronted with loss by potential fortuitous events. The term insurable interest is manifestly a misnomer; the proper term is insurable relationship. Factual expectation of damage should be the exclusive test of an insurable relationship. To those who cling to strict property delineations in fear of the process of drawing the line between a genuine factual expectation of damage and a wager, it can be said not only that judicial wisdom is equal to the task, but that a just line drawn with difficulty exceeds in value a simple line which works disproportionate injustice.’

Note: Following the strident endorsement of the legal interest test by the House of Lords in Macaura, Lord Eldon’s approach represented the orthodoxy throughout most Anglo-Commonwealth jurisdictions until the Canadian Supreme Court roundly rejected it in 1987. In Constitution Insurance Co of Canada v Kosmopoulos (below, [616]) Wilson J, relying heavily on the arguments advanced by Harnett and Thornton in the article extracted above, subjected the theoretical and policy justifications advanced in favour of the legal interest test to detailed scrutiny and, in effect, demolished them. Her clear and carefully crafted judgment warrants close reading. [616] Constitution Insurance Co of Canada v Kosmopoulos (1987) 1 SCR 2 (Sup Ct) [Kosmopoulos was the sole shareholder and director of a company that manufactured and sold leather

goods in Toronto. He effected, in his own name, a fire policy. A fire broke out in adjoining premises which resulted in fire, smoke and water damage to the company’s assets and the rented premises. The insurers denied liability]. Wilson J: [reviewed the judgment of Lawrence J and Lord Eldon’s speech in Lucena v Craufurd; describing the decision as forming ‘the substratum of the subsequent debate over the nature of an insurable interest’]. ‘Because [Lord Eldon] required a legally enforceable right, of some kind in order to constitute an insurable interest, he said that, if he had to pronounce on the first count, he would have held that the Act of Parliament did not afford a sufficient legal basis for an insurable interest since the Royal Commissioners acquired no legal rights over the ships until they reached British ports. Besides emphasising the difficulty of identifying an “intermediate thing” between a legal right and a mere expectation…Lord Eldon…stressed the problem of ascertaining the limit on who could insure…. Before turning to an examination of the later cases which considered the divergent opinions expressed in Lucena v Craufurd, it is appropriate at this point to assess the two reasons cited by Lord Eldon in support of his position. It is interesting that Lord Eldon should have advanced in support of the restrictive definition of insurable interest the virtue of certainty and pointed to the alleged lack of certainty which would, in his view, result from a broader definition. Brown and Menezes, Insurance Law in Canada (1982), at p 84, suggest the very opposite: “After Macaura, it is no longer possible to claim merely that one would be adversely affected by the loss; the insured must assert that he owned an interest in the objects

destroyed. This provides the illusion of great certainty. Property law is among the most technical and certain segments of the law. This certainty is totally illusory because the new formulation makes no concessions either to the reasons for which insurable interest is a component of insurance law or for commonplace business transactions… Assuming that an insurable interest in ‘things’ must mean property, among the simple questions raised are matters such as how does one own a direct interest in property which is not in existence at the time of the contract? Can next season’s crops or fluctuating inventory be insured? Are warehousing and other bailee policies subject to the law as set out in Macaura so as to limit the right to insure to the bailee’s liability to the bailor?” Lawrence J’s view of insurable interest avoids these problems and, in my view, provides a readily ascertainable standard. Lord Eldon’s concern that a broader definition of insurable interest would lead to too much insurance may also be illusory. Insureds will still have to disclose all material circumstances…and declare the nature of their interests…to the insurer in order to enable it to judge the risk to be taken. If the insurer cannot estimate the likelihood of the loss occurring (because, for example, the information is in the hands of third parties) then it does not have to write the policy. It can also protect, itself by limiting its liability or it can charge larger premiums. As is stated in a learned article by Bertram Harnett and John V Thornton, “Insurable Interest in Property: A Socio-Economic Re-evaluation of a Legal Concept”…“an effective curb on excessive insurance is the general ability of insurance carriers to decline risks, or insert protective clauses”. I recognise that a broadening of the definition of insurable interest may increase the liability of the insurance companies upon the occurrence of a single insured event owing to an increased number of policies for

the same risk. But insurance companies have always faced the difficult task of calculating their total potential liability arising upon the occurrence of an insured event in order to judge whether to make a particular policy or class of policies and to calculate the appropriate premium to be charged. It is not for this court to substitute its judgment for the sound business judgment and actuarial expertise of insurance companies by holding that a certain class of policies should not be made because it will result in “too much insurance”. I would have thought that a stronger argument could be made that there is too little insurance. Why should the porter in Lord Eldon’s example not be able to obtain insurance against the possibility of being temporarily out of work as a result of the sinking of the ships? As far as the insurer is concerned, how would this insurance differ from, say, health insurance covering loss of wages resulting from his own disability? If anything, the moral hazard would seem to be lower in the case of a porter’s insurance on the possibility of loss resulting from the sinking of a ship. A broadening of the concept of insurable interest would, it seems to me, allow for the creation of more socially beneficial insurance policies than is the case at present with no increase in risk to the insurer. I therefore find both of Lord Eldon’s reasons for adopting a restrictive approach to insurable interest unpersuasive. It seemed for a time as if Lord Eldon’s view was going to be abandoned and that of Lawrence J upheld. In Patterson v Harris (1861), 1 B & S 336, 121 ER 740, and in Wilson v Jones (1867), LR 2 Ex 139, courts allowed two shareholders of a company established for the purpose of laying down a trans-Atlantic submarine cable to recover on an insurance policy once the cable had been destroyed even although neither had a legally enforceable right in the cable. In Blascheck v Bussell (1916), 33 TLR 51 (Eng KB), there was no challenge to the insurable interest of the plaintiff who had insured the health of an actor he bad engaged for a

performance. That interest was a purely pecuniary, nonlegal one concerned with the consequences of’ the actor’s non-performance on account of injury. But the House of Lords in Macaura resolved the matter in favour of Lord Eldon…. Lord Buckmaster…put his support on two grounds. First, like Lord Eldon in Lucena v Craufurd, he could not understand “how a moral certainty can be so defined as to render it an essential part of a definite legal proposition”. As I have already mentioned in the context of Lord Eldon’s difficulty in identifying an “intermediate thing” between a legal right and a mere expectation, the Macaura definition, if anything, is even more uncertain than Lawrence J’s definition in Lucena v Craufurd. Secondly, he was of the view that major problems of valuation would arise…The difficulty of measuring the loss suffered by an individual shareholder should not, in my view, prevent a broadening of the definition of insurable interest. Modern company statutes…require courts in certain circumstances to value shares. The task is obviously not considered impossible. Indeed, the House of Lords knew that it was feasible at the time Macaura was decided. In Wilson v Jones, above, which the House distinguished but did not disapprove in Macaura, the court allowed an insurance based on an interest in the “adventure” of the corporation even although the insured did not own the property involved in that adventure. One might be forgiven for thinking that the interests of individual shareholders in the “adventure” of a corporation are fully as difficult of computation as the interests of individual shareholders in the assets of the corporation. Quite apart from the fact that Lord Buckmaster’s rationale for a restrictive concept of insurable interest seems somewhat less than convincing, the Macaura case is in itself a rather odd case. The case originally went to arbitration on the question of fraud. The arbitrator held that there was no fraud but that the insured had no insurable interest.

Professor Robert Keeton, Basic Text on Insurance Law (1971), has noted that “it is difficult to reject the inference that, though not proved [the charges of fraud], influenced the court to reach a theory of insurable interest that is nothing short of pernicious” (p 117). See also Brown and Menezes, above…In my view, this inference, if legitimate, further weakens the authority of Macaura as a precedent. Another curious thing about Macaura is that it has not been strictly applied in later cases. An attempt has been made to offset the arbitrariness and harshness of the Macaura principle by the use of a presumption of sorts. This presumption first appeared in the pre-Macaura case of Stock v Inglis (1884) 12 QBD 564 (CA), where Brett MR stated at p 571: “In my opinion it is the duty of a Court always to lean in favour of an insurable interest, if possible, for it seems to me that after underwriters have received the premium, the objection that there was no insurable interest is often, as nearly as possible, a technical objection, and one which has no real merit, certainly not as between the assured and the insurer.” …In view of the questionable reasoning of Lord Eldon in Lucena v Craufurd, and of their Lordships in Macaura, and in view of the fact that the allegation of fraud may have influenced the result in Macaura, the expressed reluctance in these cases to follow it to the letter is hardly surprising. In addition, the Macaura principle has not been extended to all types of insurance. Professor Marvin G Baer notes that the factual expectancy test has been used in Canada to define insurable interest in the life and health insurance fields: see Baer “Recent Developments in Canadian Law: Insurance Law”, 17 Ottawa L Rev 631 (1985), at p 655…. Nevertheless, long ago this court without referring to Lucena v Craufurd approved and adopted Lord Eldon’s view

of the nature of an insurable interest…It appears to have been accepted without question. The following comment by Harnett and Thornton, above, at pp 1162–3, on the state of the law in some American jurisdictions in 1948 may regrettably be applicable to the state of the Anglo-Canadian law on insurable interest during this century: “The requirement of insurable interest in property insurance, like most legal abstractions, has developed over the centuries primarily through judicial resolution of relatively isolated problems. Seldom have the courts examined the entire picture in terms of meaningful underlying policies, and the myopic views of older cases, canonized by precedent, often reflect themselves too brightly in later years to the detriment of sound modern analysis.” It is to such an analysis that I now turn in order to assess whether this line of authority should continue to be followed in Ontario. I begin by examining whether the current law is consistent with the policies underlying the requirement of insurable interest generally.

(1) The policy against Wagering The public policy against wagering has a long history in English law. The first statutory expression of this policy occurred in 1745 when the British Parliament enacted the Marine Insurance Act, 19 Geo 2, c 37. This policy was extended to other types of insurance by the Life Insurance Act, 1774, 14 Geo 3, c 48. At least since the enactment of these Acts English courts have consistently expressed concern that such contracts might be used to effect wagers. They have been understandably reluctant to enforce an insurance contract if it appeared to embody a wagering transaction. However, I think it is probably easy to overestimate the risk of insurance contracts being used in

today’s world to create a wagering transaction. There seem to be many more convenient devices available to the serious wagerer. If wagering should be a major concern in the context of insurance contracts, the current definition of insurable interest is not an ideal mechanism to combat this ill. The insurer alone can raise the defence of lack of insurable interest; no public watchdog can raise it. The insurer is free not to invoke the defence in a particular case or it can invoke it for reasons completely extraneous to and perhaps inconsistent with those underlying the definition: see Keeton, above, at p 117. The Macaura principle, in my view, is an imperfect tool to further the public policy against wagering. By focusing merely on the type of interest held by an insured the current definition gives rise to the possibility that an insured with the “correct” type of interest, but no pecuniary interest, will be able to receive a pure enrichment unrelated to any pecuniary loss whatsoever. Such an insured is, in effect, receiving a “gambling windfall”. But this same approach excludes insureds with a pecuniary interest, but not the type of interest required by Macaura. Such insureds purchase insurance policies to indemnify themselves against a real possibility of pecuniary loss, not to gain the possibility of an enrichment from the occurrence of an event that is of no concern to them…. Brown and Menezes, above, have shown that the public policy against wagering could not have justified that result. They state at p 71: “A corporation that has advanced $30,000 to designers of a marine drilling rig are [sic] not affronting any social antigambling norms by insuring the rig. If there is a ‘gamble’ involved, it is in backing technological development — a highly regarded activity.”

It is only where “the insured has no valuable relationship to the property or where the insurance is in excess of the insured’s interest…[that] the evils of wagering in part reappear”: see Harnett and Thornton, [who]…conclude… “While some form of valuable relationship to the occurrence is necessary to avoid the wagering aspect, the policy against wagering is satisfied by any valuable relationship which equals the pecuniary value of the insurance, regardless of the legal nature of that relationship. I agree with their conclusion and find, therefore, that the restrictive definition of insurable interest set out in Macaura is not required for the implementation of the policy against wagering.

(2) Indemnification for loss The public policy restricting the insured to full indemnity for his loss is not consistent with the restrictive definition of insurable interest set out in Macaura. Indeed, an extension of that definition may better implement the principles of indemnity. At present, insureds such as Mr Kosmopoulos who have suffered genuine pecuniary loss cannot obtain indemnification because of the restrictive definition. The Macaura case itself shows how the indemnity principle is poorly implemented by the current definition of insurable interest. Had Macaura named the corporation as the insured, or had he taken a lien on the timber to secure the debt, he would have been held to have had an adequate interest. But without these formal steps Macaura’s interest satisfied the principle of indemnity. Another case which illustrates the inadequacy of the current definition of insurable interest in furthering the indemnity principle is Zimmerman v St Paul Fire & Marine Ins Co (1968) 1 DLR (3d) 277. In that case the insured (together with another person) owned all the shares in a

company which owned a building. The insurance on the building was in the shareholder’s name. Consistent with authority it was held that the shareholder had no insurable interest in the building even although the company had long since ceased active business and had been struck off the register of companies for non-payment of fees. Had the building been transferred to the two shareholders the insured would have prevailed and, as Wood JA noted (at p 279), this was “but a matter of conforming to certain procedural formalities”. The only effect of the Macaura definition of insurable interest in such a case is to “trap the unwary person whose interest truly satisfies the principle of indemnity rather than to advance that principle”: Keeton, above, at p 117.

(3) Destruction of the subject-matter It has also been said that if the insured has no interest at all in the subject-matter of the insurance, he is likely to destroy the subject-matter in order to obtain the insurance moneys. Thus, the requirement of an insurable interest is said to be designed to minimise the incentive to destroy the insured property. But it is clear that the restrictive definition of insurable interest does not necessarily have this result. Frequently an insured with a legal or equitable interest in the subject-matter of the insurance has intimate access to it and is in a position to destroy it without detection. If Lawrence J’s definition of insurable interest in Lucena v Craufurd were adopted, this moral hazard would not be increased. Indeed, the moral hazard may well be decreased because the subject-matter of the insurance is not usually in the possession or control of those included within Lawrence J’s definition of insurable interest, ie those with a pecuniary interest only. It seems to me, therefore, that the objective of minimising the insured’s incentive to destroy the insured property cannot be seriously advanced in support of the Macaura principle.

It is no doubt true that if in fact the proceeds of insurance could be paid to a sole shareholder free of the corporation’s creditors, the sole shareholder would have a greater incentive to destroy the business assets than if the proceeds were paid into the insolvent corporation subject to the claims of its creditors. But it seems to me that the greater incentive stems from Salomon v Salomon & Co [1897] AC 22, which allows a single shareholder corporation to be treated as a different legal entity from the single shareholder. The unhappy consequences of that case for corporate creditors are well-known. Indeed, one commentator has described the Salomon decision as “calamitous”: see O Kahn-Freund, “Some Reflections on Company Law Reform”, 7 MLR. 54 (1944). Salomon nevertheless is now part of our law and, while broadening the definition of insurable interest may permit one more unhappy consequence of the Salomon principle, it would also remove another. For it is the notion of separate corporate personality which has prevented Mr Kosmopoulos and others in his position from having the kind of insurable interest required by Macaura. In my view, this is quite a price to pay for the supposed disincentive to wilful destruction of the insured property. I would accept the view expressed by Brown and Menezes, above, at p 74, to the effect that: “…insurance concepts cannot on their own prevent deliberate causing of loss. The primary burden for discouraging anti-social activity lies with the criminal justice system. Insurance principles cannot eliminate arson or murder any more than banking legislation can eliminate armed robbery.” The preceding discussion has proceeded on the assumption that corporations would not insure their own assets and that shareholders would receive the proceeds of insurance taken

out in their own names free of corporate creditors. But the circumstances in which this would occur if the definition of insurable interest were extended would be rare indeed. There exist a number of remedial devices by which courts can make the insurance proceeds held by shareholders available to the corporation in appropriate cases. Courts may be willing to imply a trust of the insurance proceeds received by an insured shareholder in favour of the corporation when it appears to implement the shareholder’s actual intention that the corporation not suffer loss as a result of the destruction of corporate property. An implied trust may also be available when a shareholder has insured for an amount in excess of full indemnity for his own loss. Normally a shareholder is only entitled to full indemnity but where there is an intention on the part of the shareholder to insure both his own pecuniary interest and the corporation’s interest, the shareholder is entitled to receive full indemnity for his own pecuniary loss and the excess is held on trust for the corporation: Keefer v Phoenix Ins Co of Hartford (1901), 31 SCR 144. If a number of shareholders similarly insure with such an intention, the corporation may be fully indemnified, in which case none of the shareholders will have suffered a pecuniary loss and all of the insurance proceeds will be held for the corporation. If it is not possible to imply a trust for the corporation, the court may consider it appropriate to lift the corporate veil and impose a constructive trust in favour of the corporation. I have already noted that while in the case of a single shareholder corporation courts are unlikely to lift the corporate veil for the benefit of that single shareholder, they may be willing to lift the corporate veil “in the interests of third parties who would otherwise suffer as a result of that choice”: Gower, Modern Company Law, 4th edn (1979) at p 138…In light of these considerations, I simply cannot imagine that a corporation would not insure the assets of the corporation in its own name. Once the corporation has insurance on its

assets, its shareholders would not suffer an injury to their pecuniary interests if some corporate property were damaged or destroyed because the corporation would be indemnified by the insurer. In such a situation the shareholders would be unable to recover under their policies and would accordingly have no incentive to destroy the corporate property. There is, therefore, in my view, little merit to the submission that a broadening of the definition of insurable interest will increase the temptation of shareholders to destroy the corporate property. In summary, it seems to me that the policies underlying the requirement of an insurable interest do not support the restrictive definition: if anything, they support a broader definition than that set out in Macaura. [Wilson J went on to note that many US jurisdictions had abandoned the legal interest test for insurable interest and observed]…no material has been referred to us by counsel to show that these developments in the United States have led to insoluble problems of calculation. In my view, there is little to commend the restrictive definition of insurable interest. As Brett MR has noted over a century ago in Stock v Inglis, above, it is merely “a technical objection…which has no real merit…as between the assured and the insurer”. The reasons advanced in its favour are not persuasive and the policies alleged to underlie it do not appear to require it. They would be just as well served by the factual expectancy test. I think Macaura should no longer be followed. Instead, if an insured can demonstrate, in Lawrence J’s words, “some relation to, or concern in the subject of the insurance, which relation or concern by the happening of the perils insured against may be so affected as to produce a damage, detriment, or prejudice to the person insuring”, that insured should be held to have a sufficient interest. To “have a moral certainty of advantage or benefit, but for those risks or dangers”, or “to be so circumstanced with respect to [the subject-matter of the

insurance] as to have benefit from its existence, prejudice from its destruction” is to have an insurable interest in it.

Notes: 1. For comment see J Birds, [1987] JBL 309. See also, RA Hasson, “Reform of the Law Relating to Insurable Interest in Property — Some Thoughts on Chadwick v Gibralter General Insurance” (1983–84) 8 Can Bus LJ 114; and RA Hasson, “The Supreme Court in Flames: Fire Insurance Decisions After Kosmopoulos” [1995] Osgoode Hall LJ 679. 2. We have seen that Wilson J referred to the unease expressed over a century ago by Brett MR (in Stock v Inglis) over adopting too strict a view of the insurable interest requirement (see also, Mackenzie v Whitworth (1875) 10 Exch 142, 148, Bramwell B; Re London County Commercial Reinsurance Office Ltd [1922] 2 Ch 67, 79, Lawrence J). Modern English judges have similarly expressed disquiet over use of this technical defence. For example, Mance J observed in Cepheus Shipping Corporation v Guardian Royal Exchange Assurance plc (The “Capricorn”) [1995] 1 Lloyd’s Rep 622 at 641, that: ‘the present policy is not on its face one which the parties made for other than ordinary business reasons; it does not bear the hallmarks of wagering or the like. If underwriters make a contract in deliberate terms which covers their assured in respect of a specific situation a Court is likely to hesitate before accepting a defence of lack of insurable interest’.

‘More recently, in Feasey v Sun Life Assurance Co of Canada [2003] EWCA Civ 885 Ward LJ, dissenting, explained that the tactic of raising lack of insurable interest in order to avoid the obligations that the reinsurers, Sun Life and Phoenix, had undertaken to the re-insured, was morally reprehensible. He said: ‘When the re-insurers began to find the business not as profitable as they had hoped, they raised their clean hands and cried foul. They sought to avoid the obligations they had undertaken to the Syndicate by alleging, inter alia, the lack of an insurable interest. They wanted their money back. When Steamship [the insured] began its proceedings against the Syndicate, the response was that the same point would have to be taken in their defence in case Sun Life and Phoenix were correct. Although it is true to say that the Syndicate sit in the middle of this litigation wringing their hands in embarrassment, leaving Sun Life and Phoenix to do the dirty work, we none the less have the extraordinary position that those who devised the plan to serve their ends now seek to avoid their liability under it on the basis that they failed to overcome the obstacle staring them in the face at all times, and known to be an obstacle, that Steamship might not be able to show they have an insurable interest in the subject-matter of this insurance. Who, I wonder, was the splendid humorist who codenamed this “conceptual proposal” “Nelson”? He or she presciently and ironically must have appreciated that it might only work if one turned the blind eye. If the re-insurers and insurers are now right, the only one to lose will be Steamship. It is hardly an attractive stance for insurers and re-insurers to adopt. Perhaps the outsider may be permitted to say that where the contract of insurance is supposed to be one requiring the utmost good faith from all parties, this stance

betrays the moral reinsurers’ position.’

bankruptcy

of

the

insurers’

and

See also the criticisms made by the Australian Law Reform Commission, Review of the Marine Insurance Act 1909, Report 91 (2001). 3. The liberal approach taken by Wilson J in Kosmopoulos is also evident in some USA jurisdictions where judges have similarly questioned whether Lord Eldon’s formulation properly meets the policy objectives underlying the interest requirement. [617] Castle Cars Inc v United States Fire Insurance Co (Virginia Supreme Court) 221 Va 773, 273 SE 2d 793 (1981) Poff J: ‘This appeal poses the question whether a bona fide purchaser for value has an insurable interest in stolen property. The facts are stipulated. Castle Cars Inc (the dealer), bought a used car for $2,600 and received the seller’s assignment of a title certificate issued by the Division of Motor Vehicles. That night the car was stolen from the dealer’s lot. The dealer filed a claim under the theft provisions of its garage keeper’s liability insurance policy with United States Fire Insurance Company (the insurer). The insurer paid the claim, and the dealer assigned the title certificate to the insurer in accordance with the subrogation provisions of the policy. Subsequent investigation disclosed that the car had been stolen from its rightful owner, but since it bore a Vehicle Identification Number plate which had been transferred by the thief from a wrecked vehicle of

similar description, the true owner was never identified. The car was never recovered, and the insurer filed suit for reimbursement from the dealer. Finding that the dealer had no insurable interest in the stolen vehicle, the trial court entered judgment for the insurer. The question we consider is one of first impression in this Court. Although courts in sister states are divided on the issue, they agree that a property insurance contract is void unless the insured has an “insurable interest” in the property insured…The reasons for the rule are grounded in public policy. “If…one insures the property of another, the contract of insurance is void and carries with it temptations to crime into which we should not be led. It is against public policy.” Liverpool, Etc, Ins Co v Bolling, 176 Va. 182, 187, 10 SE2d 518, 520 (1940). In absence of an interest in the property to be insured. [an insurance] contract becomes in essence a wager which will not be sanctioned by the courts.” Skaff v United States Fidelity & Guaranty Company, 215 So 2d, 35, 36 (Fla Dist Ct App 1968). “The anti-wagering considerations seem to be actually based on the fear that the insured will connive at the destruction of the property in order to profit from the insurance…” Annot., 33 ALR3d 1417, 1420 (1970). Courts do not agree, however, upon what constitutes an insurable interest. The disagreement apparently stems from the disparate views expressed by Lord Lawrence and Lord Eldon in the old English case of Lucena v Crauford, 2 Bos & Pul (HR) 269, 127 Eng Rep 630 (1806). Note, Insurable Interest in Property in Virginia, 44 Va L Rev 278, 279 (1958). Lord Lawrence believed that a person has an insurable interest if he has “some relation to, or concern in the subject of the insurance” which may be prejudiced “by the happening of the perils insured against” and he “is so circumstanced with respect to” the insured subject “as to have a moral certainty of advantage or benefit” sufficient to make him “interested in the safety of the thing.” 2 Bos & Pul

(HR) at 302, 127 Eng Rep at 643. Disagreeing, Lord Eldon felt that an interest is insurable only if it is a legal or equitable right enforceable in law or chancery. “[E]xpectation,” he said, “though founded on the highest probability, [is] not interest,” id., at 323, 127 Eng Rep at 651, and “[i]f moral certainty be a ground of insurable interest, there are hundreds, perhaps thousands, who would be entitled to insure” the same property, id at 324, 127 Eng Rep at 65 1. In short, Lord Lawrence held that factual expectation, if grounded in moral certainty, was sufficient, while Lord Eldon required legal or equitable entitlement. Our Court has indicated that it considers the Eldon view too restrictive. Although the interest held insurable in Tilley v Connecticut Fire Ins Co 86 Va 811, 11 SE 120 (1890), was an enforceable equitable right, the Court expressed a view in dictum much like that of Lord Lawrence: “Any person who has any interest in the property, legal or equitable, or who stands in such a relation thereto that its destruction would entail pecuniary loss upon him, has an insurable interest to the extent of his interest therein, or of the loss to which he is subjected by the casualty. Id at 813, 11 SE at 120.” The Tilley dictum influenced later decisions. In Bolling, above, we noted that “[e]verywhere there is a tendency to broaden the definition of an “insurable interest”; neither legal nor equitable title is necessary.” 176 Va at 187, 10 SE2d at 520. There, in a suit on a fire insurance policy, the plaintiff alleged that her father-in-law had authorised her to use his building to conduct a business and had promised to give it to her later. On appeal from a judgment for the plaintiff, the insurance company contended that the plaintiff had no insurable interest in the building. Quoting the dictum in Tilley, we approved the following rule:

“Any title or interest in the property, legal or equitable, will support a contract of insurance on such property. The term “interest” as used in the phrase “insurable interest” is not limited to property or ownership in the subject matter of the insurance. Where the interest of the insured in, or his relation to, the property is such that he will be benefited by its continued existence or suffer a direct pecuniary injury by its loss, his contract of insurance will be upheld, although he has no legal or equitable title. 26 CJ 20 Id at 188, 10 SE2d at 520.” In dissent, a minority of the Court observed that the plaintiff “did not have either the legal or equitable title to [the building], or any legal interest in it whatsoever.” 1d at 197, 10 SE2d at 524. Yet, the majority concluded that “[t]o hold that [the plaintiff] had no pecuniary interests in continuing this business upon which she depended for support because she had no legal title is to stick in the bark,” id at 190, 10 SE2d at 521, and held that the plaintiff had an insurable interest to the full extent of the fee simple value of the building. “The rule approved by the majority was tacitly adopted by the General Assembly. By Acts 1952, c. 317, the term ‘insurable interest’ was defined to mean ‘any lawful and substantial economic interest in the safety or preservation of the subject of insurance free from loss, destruction or pecuniary damage.’ Code § 38.1–331.” Under the facts stipulated here, the dealer had an “economic interest in the safety or preservation of the subject of insurance,” Code § 38.1–331, and that interest, measured by the purchase price, was certainly “substantial.” The insurer makes the point that the statute requires that an interest, “to be insurable, must also be a

lawful interest” and insists that “[t]he interest held by a purchaser of stolen property cannot be lawful.” Although the dealer acquired what reasonably appeared to be proper paper title to the car, it is true that it acquired no legal title; a thief takes no title in the property he steals and can transfer none. But under the rule applied in Bolling and Dalis, [206 Va 71, 141 SE 2d 721 (1965)] the interest need not be legal or equitable title to be insurable. And, as we construe the statute codifying that rule, a “substantial economic interest” is an insurable interest if it is “lawful” in the sense that it was not acquired in violation of the law. As used in this context, the word “lawful” is not synonymous with the word “legal.” An interest enforceable against the world is legal. An interest acquired in good faith, for value, and without notice of the invalidity of the transferor’s title is lawful and enforceable against all the world except the legal owner. We share the view of those courts which have held that such an interest in a stolen motor vehicle is an insurable interest… The parties agree that the dealer acquired its interest in the car as a bona fide purchaser for value without notice that the car was stolen property. Applying the principles in Bolling and Dalis and the statute as we have construed it, we hold that the interest the dealer acquired was economic, substantial, and lawful and that the trial court erred in ruling that such interest was not insurable. The judgment will be reversed and final judgment for the dealer will be entered here.’

Notes: 1. The Australian Law Reform Commission Report No 20 (1982), Insurance Contracts, has also opted for Lawrence J’s factual expectation test on the basis that it “would allow more flexibility

to insurers and to the insuring public, without in any way promoting gaming and wagering in the form of insurance or adding to the risk of destruction of the property insured” (ch 5, para 120). The ALRC’s recommendation in this respect has been given statutory effect: [618] (Australian) Insurance Contracts Act 1984 no 80 (As Amended) ‘Section 16 Insurable interest not required (1) A contract of general insurance is not void by reason only that the insured did not have, at the time when the contract was entered into, an interest in the subject-matter of the contract. Section 17 Legal or equitable interest not required at time of loss Where the insured under a contract of general insurance has suffered a pecuniary or economic loss by reason that property the subject matter of the contract has been damaged or destroyed, the insurer is not relieved of liability under the contract by reason only that, at the time of the loss, the insured did not have an interest at law or in equity in the property.’ (2) See also the New Zealand Insurance Law Reform Act 1985, section 7(1). (3) State legislation in the USA has not adopted a consistent line on the determinative test for interest in property insurance. Compare the following examples:

2.

See also the legislation:

following

extracts

from

U.S.

[619] New York Insurance Law (1993) § 3401. Insurable interest in property No contract or policy of insurance on property made or issued in this state, or made or issued upon any property in this state, shall be enforceable except for the benefit of some person having an insurable interest in the property insured. The term “insurable interest,” as used in this section, shall be deemed to include any lawful and substantial economic interest in the safety or preservation of property from loss, destruction or pecuniary damage.

[620] West’s Annotated California Insurance Code (1994) § 280. Necessity of insurable interest If the insured has no insurable interest, the contract is void. § 281. Insurable interest in property defined Every interest in property, or any relation thereto, or liability in respect thereof, of such a nature that a contemplated peril might directly damnify the insured, is an insurable interest. § 282. Property interests An insurable interest in property may consist in: 1. An existing interest; 2. An inchoate interest founded on an existing interest; or 3. An expectancy, coupled with an existing interest in that out of which the expectancy arises. § 283. Contingency or expectancy A mere contingent or expectant interest in anything, not founded on an actual right to the thing, nor upon any valid contract for it, is not insurable.

[621] Virginia Code Annotated (1993) § 38.2–303 Insurable interest required; property insurance No contract of insurance on property or of any interest therein or arising therefrom shall be enforceable except for the benefit of persons having an insurable interest in the things insured. The term “insurable interest — as used in this section means any lawful and substantial economic interest in the safety or preservation of the subject of insurance free from loss, destruction or pecuniary damage.

6.3 Factual Expectancy in the English Courts — Bailees and SubContractors The trend seen in other common law jurisdictions towards the adoption of the factual expectation test is also discernible in some modern English decisions (see, for example, Mark Rowlands Ltd v Berni Inns Ltd (above, [608]) in which the Court of Appeal adopted Lawrence J’s formulation in determining the insurable interest of a tenant). This more open textured approach is illustrated by Sharp v Sphere Drake Insurance Ltd (The ‘Moonacre’) [1992] 2 Lloyd’s Rep 501, in which Colman J, distinguishing Macaura, held that a sole shareholder possessed insurable interest in a yacht purchased by the company. The vessel was intended for his sole use and a power of attorney was granted to him in respect of it. Moreover, in Feasey v Sun Life Assurance Co of Canada [2003] EWCA Civ

885, Waller LJ concluded that the balance of authority supported the wider approach: ‘There has been some debate as to whether Lord Eldon’s test is narrower than Lawrence J’s, and as to whether Lawrence J’s test, being contained only in an advice, should be rejected in favour of Lord Eldon’s which was contained in a speech pronouncing the decision. Since Lucena v Craufurd was concerned with the insurance of property it is unnecessary to resolve that debate, but I do note that Lawrence J’s test has been approved many times in later decisions (see for example Blackburn J in Wilson v Jones (1867) LR 2 EX 139…and, more recently, Kerr LJ in Mark Rowlands v Berni Inns [1986] 1 QB 211 at 228).’

Indeed, support for Lawrence J’s factual expectation test can be found in some earlier case law going back to the nineteenth century. For example, in Wilson v Jones (1867) LR 2 EX 139 Blackburn J said that: ‘I know no better definition of an interest in an event than that indicated by Lawrence J, in Barclay v Cousins 2 East 544, and more fully stated by him in Lucena v Craufurd 2 B & PNR that if the event happens the party will gain an advantage, if it is frustrated he will suffer a loss.’ Nowadays, the determination of insurable interest has come to the fore in a series of cases involving building contractors in which the principal issue concerned the exercise of subrogation rights by insurers. It will seen that the courts in these cases have enlisted decisions concerning bailees insuring property in their custody as a means of supporting the move away from the legal interest test towards

finding that sub-contractors possess a pervasive interest in the whole construction site. In State of the Netherlands v Youell and Hayward [1997] 2 Lloyd’s Rep 440 at 448, Rix J noted that: ‘A pervasive interest…partakes of certain characteristics of both a separate and a joint interest for the very good reason that in such a case the claimant is entitled to claim not only for himself but also for the benefit of his coassureds in the full amount of the loss.’ [622] Waters v Monarch Life and Assurance Co (1856) 5 El & Bl 870

Fire

[The claimants, who were flour merchants, warehousemen and wharfingers, effected two floating insurance policies. The first covered property deposited in their warehouse on trust or held on commission against loss or damage by fire. The second policy, in the same form as the first, covered property which they owned or held on commission. A fire destroyed flour owned by the claimants’ customers. Although one customer in particular had knowledge of the insurance the other owners in question were ignorant of the existence of the policies and had effected their own insurance cover. The insurers argued that their liability to the claimants did not extend beyond meeting the warehousing charges due to them on the basis that that represented the extent of their insurable interest in the flour]. Lord Campbell CJ:

‘I cannot doubt the policy was intended to protect such goods; and it would be very inconvenient if wharfingers could not protect such goods by a floating policy…And I think that a person entrusted with goods can insure them without orders from the owner, and even without informing him that there was such a policy. It would be most inconvenient in business if a wharfinger could not, at his own cost, keep up a floating policy for the benefit of all who might become his customers. The last point that arises is, to what extent does the policy protect those goods. The defendants say that it was only the plaintiffs’ personal interest. But the policies are in terms contracts to make good “all such damage and loss as may happen by fire to the property hereinbefore mentioned.” That is a valid contract; and, as the property is wholly destroyed, the value of the whole must be made good, not merely the particular interest of the plaintiffs. They will be entitled to apply so much to cover their own interest, and will be trustees for the owners as to the rest. The authorities are clear that an assurance made without orders may be ratified by the owners of the property, and then the assurers become trustees for them.’

Crompton J: ‘The parties meant to insure those goods with which the plaintiffs were entrusted, and in every part of which they had an interest, both in respect of their lien and in respect of their responsibility to their bailors. What the surplus after satisfying their own claim might be, could only be ascertained after the loss, when the amount of their lien at that time was determined; but they were persons interested in every particle of the goods.’

[623] Tomlinson(Hauliers) Ltd v Hepburn [1966] AC 451 (HL)

[The claimants were carriers and they insured a consignment of cigarettes in respect of which they had contracted with the manufacturer, Players, to transport. The cigarettes were stolen without any fault or liability on the part of the plaintiffs. The insurers repudiated the claim on the ground that in the absence of any liability on the part of the plaintiffs there was no loss in respect of which they required indemnification]. Lord Reid: ‘The appellant’s main defence is that all insurances of this kind are contracts of indemnity, that the respondents have suffered no loss and have incurred no liability to Players as a result of the theft, and that therefore the appellant cannot have any liability under the policy. The respondents do not argue that they acted as Players’ agents in contracting with the appellant. They rely on their own insurable interest: they say that they were entitled to and did insure for the full value of the goods up to the limit set out in the policy, that they are entitled to recover such value and that they will be bound to pay to Players any sum which they recover from the appellant. The case must, in my view, depend on the true construction of the policy, but before considering its provisions I think it best to consider the principles of law applicable to such cases. There can be no doubt that a bailee has an insurable interest in goods entrusted to him, and it has not been denied that the respondents were bailees of the cigarettes when they were stolen. I think that the law was accurately stated by Lord Campbell in Waters v Monarch Fire & Life Assurance Co [see above, [622]]… In no case cited to us has there been any adverse criticism of that passage. A bailee can if he chooses merely insure to cover his own loss or personal liability to the owner

of the goods either at common law or under contract and if he does that of course he can recover no more under the policy than sufficient to make good his own personal loss or liability. But equally he can if he chooses insure up to his full insurable interest-up to the full value of the goods entrusted to him. And if he does that he can recover the value of the goods though he has suffered no personal loss at all. But in that case the law will require him to account to the owner of the goods who has suffered the loss or, as Lord Campbell says, he will be trustee for the owners. I need not consider whether this is a trust in the strict sense or precisely on what ground the owner can sue the bailee for the money which he has recovered from the insurer. A similar situation would arise if a bailee sued a wrongdoer for the full value of goods converted or destroyed by him; there is no doubt that such an action can succeed and equally I would think that there can be no doubt that the bailee must then account to the true owner. The fact that a bailee has an insurable interest beyond his own personal loss if the goods are destroyed has never been regarded as in any way inconsistent with the overriding principle that insurance of goods is a contract of indemnity. The question is whether the bailee has insured his whole insurable interest — in effect has taken out a goods policy or whether he has only insured against personal loss — has taken out a personal liability policy. The answer to that question must depend on the true construction of the policy…This case has been complicated by the supposed existence of a rule that, if the insurer has only a limited interest in the subjects insured, he cannot recover more than sufficient to indemnify him against his own personal loss, unless it is shewn that he intended to insure for the benefit of the owner of those subjects. It is said that under this supposed rule that intention need not appear from the terms of the policy and need not have been communicated to the insurer, but that the intention can be

proved by evidence. But it is a fundamental principle that the construction of a contract cannot be governed or affected by the intention or belief of one of the parties not communicated to the other: and for very good reason. It would be most unfair if one party were to find his apparent rights under the contract altered by reason of some state of mind of the other party of which he was not and could not be aware. The supposed rule appears to have been deduced by text writers from obiter dicta of Bowen LJ in Castellain v Preston (1883) 11 QBD 380, 397–99 and it appears to me to have arisen from failure to distinguish cases where the assured insures his own insurable interest from cases where, as in marine insurance policies, he is insuring on behalf of undisclosed principals. Under the ordinary law of principal and agent an undisclosed principal cannot come in to take advantage of a contract unless the agent intended to act on his behalf. The law of marine insurance may not correspond in all respects with the ordinary law of principal and agent, but I see nothing really anomalous in it. It is however a very different matter when the insurer is insuring on his own behalf. In the present case Players are not coming in as undisclosed principals and there is no room for the introduction of a requirement that the respondents must have intended to act as their agents or on their behalf. If there were any question whether the policy is a wagering policy, intentions would be relevant, but no such question arises in this case and it could hardly arise in a case of this character… In my judgment, this policy on its true construction must be held to be a policy on goods, and the respondents are entitled torecover under it the value of the goods up to the limits expressed in the policy. But the law will require them to account to Players, the owners of the goods, for what they do not require for their own indemnification.’

Lord Pearce:

‘The bailee of goods…has a right to sue for conversion, holding in trust for the owner such damages as represent the owner’s interest…It would seem irrational…if he could not also insure for their full value. Both those who have the legal title and those who have a right to possession have an insurable interest…There seems, therefore, no reason in principle why they should not be entitled to insure for the whole value and recover it. They must, however (like plaintiffs in actions of trover or negligence), hold in trust for the other parties interested so much of the moneys recovered as is attributable to the other interests.’

[624] Petrofina (UK) Ltd v Magnaload Ltd [1983] 2 Lloyd’s Rep 91 [A Contractors All Risks policy defined the insured as the ‘contractors and/or subcontractors’. The issue was whether sub-contractors (Magnaload and Mammoet) on a construction site possessed insurable interest in the entire works despite the fact that they were working only on limited parts of the site. An affirmative answer would mean that the insurers would be prevented from exercising subrogation rights against the sub-contractors in respect of damage to the works, which also resulted in the death of two workmen, allegedly caused by their negligence]. Lloyd J: ‘If the defendants are not sub-contractors within the meaning of the policy, the insurers would have had a complete defence. On the true construction of the policy I would hold that Magnaload and Mammoet were both subcontractors and both insured under the policy.

The next question relates to the property insured. Mr Hamilton [counsel for the defendants] submits that a Contractors All Risk policy in this form is an insurance on property, namely, the works and temporary works belonging to the insured, or for which the insured are responsible. Mr Wright [counsel for the claimants] accepts that it is an insurance on property, but submits that the property insured must be read distributively, in other words, each insured is only insured in respect of his own property, or property for which he is responsible. I do not accept that construction. It seems to me that on the ordinary meaning of the words which I have quoted, each of the named insured, including all the sub-contractors, are insured in respect of the whole of the contract works. There are no words of severance, if I may use that term in this connection, to require me to hold that each of the named insured is only insured in respect of his own property. Nor is there any business necessity to imply words of severance. On the contrary, as I shall mention later business convenience, if not business necessity, would require me to reach the opposite conclusion. I would hold, as a matter of construction, that each of the named insured is insured in respect of the entire contract works, including property belonging to any other insured or for which any other insured is responsible. But then comes the question: What is the nature of the interest insured? Mr. Wright submits that the only possible insurable interest which one insured could have in property belonging to another, is in respect of his potential liability for loss of or damage to that property. Accordingly section 1 of the present policy is, he submits, a composite insurance. It is an insurance on property so far as it relates to property belonging to any particular insured; it is a liability insurance so far as it relates to all other property comprised in “contract works”.

Mr Hamilton on the other hand, submits that section 1 of the policy is a policy on property, pure and simple. In my judgment Mr Hamilton’s submission is correct. A very similar question arose in A Tomlinson (Hauliers) Ltd v Hepburn, [see above, [623]]…It was common ground that the carriers were not liable to the owners. On the carriers making a claim under the policy, for the benefit of the owners, it was argued that the policy was a liability policy, and since the carriers were not liable to the owners, they could not recover from the insurers. The argument was rejected by Mr Justice Roskill and his judgment was upheld by the Court of Appeal and the House of Lords. It appears that underwriters had always regarded an insurance on Form J as being a liability policy, and not a policy on goods. But Lord Reid said that the language of the policy showed conclusively that the policy was a policy on goods. I can find no relevant distinction between the language of the present policy and the language in Tomlinson v Hepburn. Section 1 of the present policy covers “…all risks of loss or damage to the insured property.” It excludes the cost of replacing or rectifying insured property which is defective in material or workmanship; and so on. There is nothing in section 1 of the policy which is appropriate to an insurance against liability, whereas everything is appropriate to a policy on property…Section 3 [of the policy] covers third party liability. The very fact that third party liability is covered in a separate section, which expressly excludes liability for damage to property forming part of the contract works, shows to my mind that section 1 of the policy is an insurance on property, and not an insurance against liability… That brings me to the central question in the case. In Tomlinson v Hepburn it was held indeed it was conceded — that if the policy was an insurance on goods, then the carriers could, as bailees, insure for their full value, holding the proceeds in trust for the owners. In the present case the

defendants could not be regarded as being in any sense bailees of the property insured under the policy. Does that make any difference? Can the defendants recover the full value of the property insured, even though they are not bailees? It is here that one leaves the construction of the policy, and enters, hesitatingly, the realm of legal principle. What are the reasons why it has been held ever since Waters & Steel v Monarch Fire and Life Assurance Co, [see above, [622]] that a bailee is entitled to insure and recover the full value of goods bailed? Do those reasons apply in the case of the sub-contractor? One reason is historical; the bailee could always sue a wrong-doer in trover. If his possessory interest in the goods was sufficient to enable him to recover the full value of the goods in trover, why should he not be able to insure that interest? Another reason was that, as bailee, he was “responsible” for the goods. Responsibility is here used in a different sense from legal liability. A bailee might by contract exclude his legal liability for loss of or damage to the goods in particular circumstances, eg, by fire. But he would still be “responsible” for the goods in a more general sense, sufficient, at any rate, to entitle him to insure the full value. It is clear that neither of these reasons apply in the case of a sub-contractor. But there is a third reason which is frequently mentioned in connection with a bailee’s right to insure the full value of the goods. From a commercial point of view it was always regarded as highly convenient [in support of this view Lloyd J cited dicta in Waters v Monarch, Lord Campbell and Tomlinson v Hepburn, Lord Pearce]… In the case of a building or engineering contract, where numerous different sub-contractors may be engaged, there can be no doubt about the convenience from everybody’s point of view, including, I would think, the insurers, of allowing the head contractor to take out a single policy

covering the whole risk, that is to say covering all contractors and sub-contractors in respect of loss of or damage to the entire contract works. Otherwise each subcontractor would be compelled to take out his own separate policy. This would mean, at the very least, extra paperwork; at worst it could lead to overlapping claims and cross claims in the event of an accident. Furthermore…the cost of insuring his liability might in the case of a small subcontractor, be uneconomic. The premium might be out of all proportion to the value of the sub-contract. If the subcontractor had to insure his liability in respect of the entire works, he might well have to decline the contract. For all these reasons I would hold that a head contractor ought to be able to insure the entire contract works in his own name and the name of all his sub-contractors, just like a bailee or mortgagee, and that a sub-contractor ought to be able to recover the whole of the loss insured, holding the excess over his own interest in trust for the others. If that is the result which convenience dictates is there anything which akes it illegal for a sub-contractor to insure the entire contract works in his own name? This was a question which was much discussed in the early cases on bailment. But it was never illegal at common law for a bailee to insure goods in excess of his interest. As for statute, the Marine Insurance Acts obviously do not apply. It is true that the Life Assurance Act, 1774, by section 3 prohibited an insured from recovering more than his interest on the happening of an insured event. But policies on goods were specifically excluded by section 4 of the Act. Accordingly it was held that neither at common law nor by statute was there anything to prevent the bailee from insuring in excess of his interest. What about a sub-contractor? “Goods” in section 4 of the Life Assurance Act, 1774, has always been given a wide interpretation, and would clearly cover contract works until they became part of the realty. Whether the works would

remain “goods” thereafter, and if so for how long, may be more difficult. But it was not suggested that the insurers would have any defence here under the Life Assurance Act, so I say no more about it. I would hold that the position of a sub-contractor in relation to contract works as a whole is sufficiently similar to that of a bailee in relation to goods bailed to enable me to hold, by analogy, that he is entitled to insure the entire contract works, and in the event of a loss to recover the full value of those works in his own name. Turning from principle to authority, there is, so far as I know, no English decision covering the present case. But there is an important decision of the Supreme Court of Canada. In Commonwealth Construction Co Ltd v Imperial Oil Ltd., 69 DLR 3rd 558 (1977), the facts were that Imperial Oil Ltd. entered into a building contract for the construction of a fertiliser plant with Wellman Lord Ltd. as main contractor. Wellman Lord Ltd. entered into a subcontract with Commonwealth Construction Co Ltd for the construction of the pipework. Imperial took out a policy known as a “Course of Construction Policy”. The policy was in the name of Imperial, together with their contractors and sub-contractors. It covered “…all materials…and other property of any nature whatsoever owned by the insured or in which the insured may have an interest or responsibility or for which the insured may be liable or assume liability prior to loss or damage…” There was a fire at the site which was said to have been due to the negligence of Commonwealth. The insurers paid the loss to Imperial, and then sought to recover in the name of Imperial from Commonwealth under their right of subrogation. It will be seen that the facts are thus almost identical to those in the present case.

The matter came before the Court on a preliminary issue. The Court at first instance rejected the claim on the ground that Commonwealth were fully insured under the policy. The Court of Appeal reversed the trial Judge, holding that Commonwealth could only claim to be indemnified under the policy to the extent of that part of the work performed under the sub-contract, ie, property belonging to Commonwealth and property for which it was responsible before the loss occurred. The Supreme Court, consisting of the Chief Justice and eight Judges, restored the judgment of the trial Judge. The Supreme Court stated the main issue as follows: “Did Commonwealth, in addition to its obvious interest in its own work, have an insurable interest in the entire project so that in principle the insurers were not entitled to subrogation against that firm for the reason that it was an assured with a pervasive interest in the whole of the works.” There was a preliminary question whether the policy was to be regarded as an insurance on property at all or whether it was an insurance against liability. The Supreme Court held that it was property insurance. Indeed there seems to have been no real argument to the contrary. At the beginning of their judgment the Court described the policy as a “…multiperil subscription policy stated to be property insurance which it clearly is”… Having decided that preliminary question in favour of Commonwealth, the Court went on to consider whether Commonwealth had a “pervasive interest” in the entire property. The judgment refers to Waters & Steel v Monarch Fire and Life Assurance Co, Tomlinson v Hepburn, and other bailment cases, including a number of American cases, and then said:

“In all these cases there existed an underlying contract whereby the owner of the goods had given possession thereof to the party claiming full insurable interest in them based on the special relationship therewith. Although in the case at Bar Commonwealth was not given the possession of the works as a whole, does the concept apply here? I believe so. On any construction site and especially when the building being erected is a complex chemical plant, there is ever present the possibility of damage by one tradesman to the property of another and to the construction as a whole. Should this possibility become reality, the question of negligence in the absence of complete property coverage would have to be debated in court. By recognising in all tradesmen an insurable interest based on that very real possibility, which itself has its source in the contractual arrangements opening the doors of the job site to the tradesman, the courts would apply to the construction field the principle expressed so long ago in the area of bailment. Thus all the parties whose joint efforts have one common goal, e.g. the completion of the construction would be spared the necessity of fighting between themselves should an accident occur involving the possible responsibility of one of them.” The Commonwealth Construction Co. case is in my view, indistinguishable from the present case, and is high persuasive authority. Even if I had thought it wrongly decided, which I do not, I should have hesitated long before declining to follow it… For the reasons which I have mentioned, I would hold, both on principle and on the authority of the Commonwealth Construction Co case, that a sub-contractor who is engaged on contract works may insure the entire contract works as well as his own property, and that the defendants in this case were each so insured.

That brings me to the last question: does the fact that the defendants are fully insured under the present policy defeat the insurer’s right of subrogation? In the Commonwealth Construction Co case and in the American cases there referred to, it was assumed that it followed automatically that the insurers could have no right of subrogation. In the Commonwealth Construction Co case it was described as being a “basic principle”. In one of the American cases it was said that the rule was too well established to require citation. In none of the cases is there any discussion as to the reason for the rule… The question whether there is a fundamental principle of the law of insurance that insurers can never sue one coinsured in the name of another came up in The Yasin, [1979] 2 Lloyd’s Rep 45. In that case I said that I was not satisfied that there was any such fundamental principle as had been suggested; the reason for the rule seemed to me to rest on ordinary principles of circuity… Thus where a bailee is insured against liability to the bailor, and the bailor is insured under the same insurance, it is obvious that the insurer could not exercise a right of subrogation against the bailee; circuity would be a complete answer. But in The Yasin I went on to contrast the position where the bailee had insured, not his liability to the bailor, but the goods themselves. Now that the matter has been argued again, I have come to the conclusion that the contrast I was seeking to draw is fallacious. Whatever be the reason why an insurer cannot sue one co-insured in the name of another (and I am still inclined to think that the reason is circuity) it seems to me now that it must apply equally in every case of bailment, whether it is the goods which the bailee has insured, or his liability in respect of the goods. The same would also apply in the case of contractors and sub-contractors engaged on a common enterprise under a building or engineering contract. Even if I still had reservations of the kind which I tried to voice in The Yasin, I

would feel obliged to bury them in the light of the decision of the Supreme Court of Canada in the Commonwealth Construction Co case, a decision which was not cited in The Yasin and for the reference to which in the present case I am very grateful to Counsel.’

[625] Glengate-KG Properties Ltd v Norwich Union Fire Insurance Society Ltd [1996] 1 Lloyd’s Rep 614 (CA) [The claimants were redeveloping a defunct departmental store in Oxford Street, London. A fire occurred which damaged the building and destroyed the architects’ plans and drawings. Copies of the plans and drawings were not kept and so the architects had to reproduce them at considerable expense. The plans and drawings were not insured. The issue was whether a clause in the claimants’ consequential loss policy to the effect that at the time of the damage they must have ‘an insurance covering the interest of the insured in the property at the premises against such damage’ gave them an insurable interest in the drawings which were owned by the architects. The Court of Appeal held (Neill; Auld LJJ and Sir Iain Glidewell) that the insured had an insurable interest in the drawings (so as to cover their consequential loss) despite their lack of proprietary interest in them]. Auld LJ: ‘Although the term “insurable interest” may have a constancy of meaning in the broad sense stated by Mr Justice Lawrence in Lucena v Craufurd the nature of the

insurable interest in each case must depend on the type of cover in issue. In the case of insurance against cost of repair or reinstatement of damaged property, the insureds relationship to the property, to qualify as an insurable interest, must normally be of a proprietary or contractual nature. Mark Rowlands Ltd v Berni Inns Ltd is an example of both a proprietary and contractual relationship, and Lord Justice Kerr’s reliance on the broad proposition of Mr Justice Lawrence in Lucena v Craufurd was unnecessary on the facts of the case. Bailees are a long established and special example of a possessory insurable interest. See Waters v Monarch Fire and Life Assurance Co…But not every contractual interest in property creates an insurable interest in it for the purpose of material damage cover. The authorities do not suggest that contractual licensees have such an interest for that purpose as a general rule. However, a contractual licensee, or even one at will, may have it if he is in joint occupation of property with the licensor…Different considerations apply to cover for consequential loss such as interruption of business. I say that insurable interest for material damage cover must “normally” be proprietary or contractual because the Courts have acknowledged the presence of an insurable interest in other circumstances. See, for example, Petrofina (UK) Ltd v Magnaload Ltd… in which Mr Justice Lloyd expressed the view that a sub-contractor had an insurable interest in the main contract works analogous to that of a bailee in goods bailed to him. Mr Justice Colman followed that reasoning in two cases in which he held that a supplier of property involved in a common project with the person to whom the property has been supplied may have an insurable interest m the property. The first was Stone Vickers v Appledore Ferguson Shipbuilders Ltd, in which (sitting then as Mr. Anthony Colman, QC, a Deputy High Court Judge) he stated…that a risk of being “materially

adversely affected by loss of or damage to” the contract works “by reason of the incidence of any of the perils insured against” was capable of amounting to “a sufficient [insurable] interest in the whole contract works”. (Reversed on another point…. The second was National Oilwell (UK) Ltd v Davy Offshore Ltd, in which he held…that an insurable interest could be found in “…the assureds proximate physical relationship to the property in question.” In both cases he could, as his own treatment in each makes plain, have justified his conclusion on the narrower basis that the insurable interest derived from the supplier’s potential entitlement and/or liability under the contract with the person supplied. See also The Moonacre [noted above], where Mr Justice Colman held…that two powers of attorney granted by a company to its effective owner to enjoy the use of the company’s boat exclusively for his own purposes was “a valuable benefit” constituting an insurable interest in the boat. Cf Macaura v Northern Assurance Co Ltd…where the insurance cover in issue is against some loss consequential on damage to property, there is no reason why there should be so close a legal relationship between the insured and the object damaged. The insurable interest is in the event insured against rather than in the object the damage to which causes that event. See MacGillivray & Parkington on Insurance Law, 8th edn, p 54, para 129… Here, the insurable interest in question under the proviso was that in respect of damage to property under the material damage policy, that is, “the property of the insured or for which…they are responsible”, not that in respect of loss of rent resulting from such damage under the consequential loss policy. That is why the proviso requires that there shall be in force, under Section 1 or otherwise an insurance covering the interest of the insured in the property…against such damage. In my view, the proviso only required Glengate to insure against material damage its own property or that in respect

of which the cost of repair or replacement would fall on it. I do not consider that Glengate’s possible licence to use the design represented by the drawings or its expectation of ownership of the drawings on completion of the project or its contingent liability under cause 4.37 of the RIBA Conditions of Engagements to pay the architects’ for the work of preparing replacement drawings gave it a sufficient proprietary or contractual interest in the drawings themselves to make them an insurable interest under the material damage policy….’

Sir Iain Glidewell: ‘It is, however, a fundamental principle of insurance law that a person who has no personal property interest may nevertheless have an insurable interest in property. Indeed, he must have such an interest to be entitled to insure the property. In Mark RowIands Ltd v Berni Inns Ltd this Court specifically adopted and approved the classic definition of an insurable interest given by Mr Justice Lawrence in Lucena v Craufurd: “A man is interested in a thing to whom advantage may arise or prejudice happen from the circumstance which may attend it;…and to whom it importeth that its condition as to safety or other qualities should continue…To be interested in the preservation of a thing, is to be so circumstanced with respect to it as to have benefit from its existence, prejudice from its destruction.” Clearly an insurable interest so defined will include, but is wider than, a personal property interest. The issue for our decision can therefore be expressed as: does “the interest of the insured in the property” within the proviso include an insurable interest which is not a personal property interest?…In my judgment, the phrase “the

interest of the insured in the property” in its context in a policy of insurance covers whatever interest the insured has, including an insurable interest which is not a personal property interest… On the facts of the present case, Glengate clearly had an interest in the continued existence of the architects’ drawings. In my judgment they therefore had an insurable interest in those drawings. I see no unfairness or illogicality resulting from my conclusion. Since Glengate had an insurable interest, they could themselves have insured the architects’ drawings under the material damage policy. Alternatively (and more probably) they could have required the architects themselves to take out such insurance, which would have satisfied the proviso. In the absence of any such insurance, however, it is my judgment that the proviso applied and was not satisfied.’

Notes: 1. As commented by Auld LJ, the decision in Petrofina was extended in National Oilwell Ltd v Davy Offshore (UK) Ltd [1993] 2 Lloyd’s Rep 582, so as to encompass suppliers. Colman J held that the suppliers of a subsea wellhead completion system for a floating oil production facility were co-insureds under the Contractors All Risks policy. The suppliers’ insurable interest could be found in ‘the insured’s proximate physical relationship to the property in question.’ Citing Lloyd J’s judgment in Petrofina, Colman J said: ‘There is, in my judgment, in particular no reason in principle why such a supplier should not, and every

commercial reason why he should, be able to insure against loss of or damage to property involved in the common project not owned by him and not in his possession. The argument that because he has no possessory or proprietary interest in the property he can have no insurable interest in it and that his potential liability in respect of loss of or damage to it is insufficient to found such an insurable interest is in my judgment misconceived.’

2. See further, Co-operative Retail Services Ltd v Taylor Young Partnership 74 Con LR 12. Finding that sub-contractors possessed a pervasive interest in the whole works, both the trial judge and Brooke LJ, referred extensively to Petrofina, and, in particular, to Lloyd J’s use of the Commonwealth Construction case. Brooke LJ’s judgment was approved when the case went to the House of Lords [2002] UKHL 17. 3. A temporal limit was imposed on this broader conception of insurable interest by the Court of Appeal in Deepak Fertilisers & Petrochemical Corporation v Davy McKee (London) Ltd and ICI Chemicals and Polymers Ltd (see below, [626]). The Court agreed that a sub-contractor in a building contract possessed an insurable interest in the entire works during construction. But, once the work had been completed such interest came to an end. This is because an all risks policy on a building project is property insurance. Therefore, once the construction is completed, the contractors no longer have such

an interest in the property. They must effect a separate policy to cover any potential liability for negligence or breach of contract which results in damage to the building arising after completion. [626] Deepak Fertilisers & Petrochemical Corporation v Davy McKee (London) Ltd and ICI Chemicals and Polymers Ltd [1999] 1 Lloyd’s Rep 387 (CA) [A methanol plant in India constructed for Deepak exploded a few months after it was commissioned. A ‘Marine-cum-Erection’ policy had been effected under which both contractors and sub-contractors were named as co-assureds. The sub-contractors included Davy McKee, a firm of consulting engineers, and ICI, who had provided expertise and technology. The material terms of the agreement between Deepak and Davy provided: Art 10.10.2

Art 10.10.3

Deepak shall indemnify and hold Davy and its employees harmless from and against any and all liability for death, illness or injury to any employee of Deepak’s or for loss or damage to the property of Deepak or the property of [their] personnel and shall cause Davy to be named as co-insured in all policies of insurance effected in respect of the Plant all rights of subrogation against Davy being waived.” For the purposes of this Article Davy shall include the licenser ICI and their employees

and Deepak shall include all associated organisations, its contractors and their personnel].

Stuart-Smith LJ: ‘The learned Judge concluded that Davy (and ICI) had an insurable interest in the plant: “As long as they are arguably responsible for damage to it. Since it was Deepak’s case that Davy and ICI were responsible for the explosion, even though it occurred after a time which Deepak accept saw completion of the plant, there was no reason in principle why Davy and ICI should not be entitled to insure against their potential liability.” Mr Havelock-Allan [counsel for Deepak] seeks to impugn that finding. He contends that a party, having no proprietary or possessory interest in a property, does not have an insurable interest in that property merely because loss of or damage to that property may result from a breach of contract or duty on its part giving rise to a liability in damages to the owner of the property. Alternatively, if the contractor or sub-contractor engaged in connection with the construction of a building ever has an insurable interest in the building itself, he does not have such an interest after construction of the building has been completed merely because the building may suffer loss or damage thereafter as a result of some breach of contract or duty on his part. Mr Wilmot-Smith for Davy (and Mr Mowschenson on behalf of ICI) submit that there was no reason why Davy should not have an insurable interest in the plant which existed during the period of construction the commissioning (which was completed on 31 Jan 1992) and beyond 10 Aug 1992 when the construction of the plant was complete. Thus the question to be determined is whether Davy would have had an insurable interest in the plant itself. In

the absence of such interest no question could arise of Davy insuring the plant or Deepak doing so on Davy’s behalf. In our judgment, the answer to this issue is not complex. Davy may well have had an insurable interest in the plant whilst it was under construction and commissioning… In our judgment Davy undoubtedly had an insurable interest in the plant under construction and on which they were working because they might lose the opportunity to do the work and to be remunerated for it if the property or structure were damaged or destroyed by any of the “all risks”, such as fire or flood. Thereafter Davy would only suffer disadvantage if the damage to or destruction of the property or structure was the result of their breach of contract or duty of care. In order to protect the contractor and sub-contractors against the risk of disadvantage by reason of damage or destruction of the property or structure resulting from their breach or contract or duty they would, in accordance with normal practice, take out liability insurance or, in the case of architects, professional indemnity insurance. We consider Mr Havelock-Allan’s submission is well founded; what they cannot do is persist in maintaining an insurance of the property or structure itself. Two dates are critical. The commissioning of Deepak’s plant was completed on 31 Jan 1992. Davy continued to work on the plant thereafter to rectify construction defects but, by 10 Aug 1992, all known construction defects had been rectified and rectification work had been inspected. At the latest the construction of the plant was complete by 11 Aug. Thereafter, with effect from 11 Aug 1992, Deepak transferred the insurance of the plant from the Marine-cumErection Policy (under which Davy and “other Contractors and Sub-contractors appointed from time to time had been named as co-assured) to the conventional property insurance policy under which the existing ammonia plant was already insured (ie the “Fire Policy”). Davy was not named as a co-insured under this policy. Thus by the time

the insurance of the plant was switched to the “Fire Policy”, Davy was no longer bound to be prejudiced if the plant was damaged or destroyed by an insured peril. Accordingly, we must differ from the approach adopted by the [trial] Judge. He held that he could see no reason why Davy (and ICI) should not have an insurable interest in the plant so long as they were arguably responsible in some way for damage to it. He posed the question: “Why should not an architect or any technical designer or constructor be able to insure himself against his liability for damages to a structure due to his fault, even though the structure fails after its completion?” They could, of course, do so. This would be by means of liability insurance. Even if Davy (and ICI) or any of the subcontractors had been named in the subsequent “Fire Policy” they would not have been covered in respect of their breach of contract or duty under that policy. We therefore reverse the Judge’s findings on this issue and hold that Davy had no insurable interest in the plant on 30 Oct 1992, the date of the explosion, giving rise to Deepak’s claims.’

Note: The cases involving insurance of construction works by subcontractors were considered by Waller LJ in Feasey v Sun Life Assurance Co of Canada (below, [627]) who concluded that the basis of their insurable interest was not their potential liability in the event of causing damage to the works but rather their potential pecuniary loss should the works be damaged. Further, he thought that sub-contractors also had an interest in their own liability so that even property insurance, if so framed, could be construed

to cover such liability. You should note the narrow view taken by Waller LJ towards Deepak: [627] Feasey v Sun Life Assurance Co of Canada [2003] EWCA Civ 885 [The issue concerned insurable interest in the lives of employees — see further chapter 7, below]. Waller LJ: ‘There are various points to make on Deepak. First, so far as the all risks policy during the currency of the contract period was concerned, an insurable interest even on property seems to go beyond a “legal or equitable” interest in the property. A sub-contractor’s insurable interest on the judgments in Deepak flows from the pecuniary loss that he will suffer from the loss of the opportunity to do work if the plant was destroyed by fire. Secondly Deepak recognises unsurprisingly that a sub-contractor has an insurable interest in his own liability for negligence which he can also insure. But third, in Deepak it was common ground that if Davy were co-insureds they would have a complete answer to the subrogated claim even if damage was due to their negligence. It was thus unnecessary for the Court of Appeal to analyse or deal with how if Davy as sub-contractor was a co-insured it had an insurable interest in the whole plant and thus how as a co-insured Davy would have an answer to any subrogated claim if the explosion had occurred during the period of construction, unless Davy’s insurable interest during this period included Davy’s liability in negligence or in contract. In the judgment reference is made to Petrofina (UK) Ltd v Magnaload Ltd [1983] 2 Lloyd’s Rep 91; [1984] 1 QB 127; Stone Vickers Ltd v Appledore Ferguson Ship Builders Ltd [1991] 2 Lloyd’s Rep 288 and National Oil Wells (UK) Ltd v Davy Offshore Ltd [1993] 2 Lloyd’s Rep 582. No

disapproval is expressed of those decisions; it is simply said that “in each case the insurable interest subsisted during construction and commissioning.” Those decisions were themselves at first instance being respectively of Lloyd J, Mr Anthony Colman QC sitting as a Deputy Judge of the High Court and Colman J as he then became. Petrofina was however also approved in the Court of Appeal (save in one immaterial respect) in Mark Rowlands Ltd v Berni Inns Ltd [1986] 1 QB 211. They have been followed in Hopewell Project Management Ltd v Ewbank Preece Ltd [1998] 1 Lloyd’s Rep 448 a decision of Mr Recorder Jackson QC (as he then was). Petrofina, Stone Vickers, and National Oil Wells were also extensively analysed and approved so far as material in the judgment of Brooke LJ in Co-operative Retail Services Ltd v Taylor Young Partnership & ors 74 Con LR 12 or Court of Appeal transcript 4 July 2000. That judgment was itself approved when the case went to the House of Lords [2002] UKHL 17. These decisions hold that persons in the position of subcontractors have an insurable interest in the work or plant as a whole; the definition of that interest relied on in those authorities comes originally from a judgment in the Canadian Supreme Court, Commonwealth Construction Co v Imperial Oil (1976) 69 DLR (3rd) 558 which in terms recognised the insurable interest of sub-contractors “having its source in the very real possibility (“may”) of liability, considering the close relationship of the labour performed by the various trades under their respective agreements….”. They held further that sub-contractors can recover from insurers the full value of the works holding (where appropriate) the balance beyond their interest in trust for the owner. They further held most relevantly that sub-contractors can defeat a subrogated claim based on the sub-contractor’s liability in negligence to the owner because the insurers were pursuing a claim in relation to the loss covered by the policy.

MacGillivray on Insurance Law 10th Edition is critical of these decisions and indeed suggests Deepak has added force to the criticism [see para 1–155 to 1–157]. It may be as reflected in paragraph 1–159 of MacGillivray that the true answer is that the risk of being held liable for causing damage to property, will not by itself create an insurable interest in the property, but if there is a further legal link that interest may also be embraced within the subject of the insurance. I suggest that the question truly is one of construction. It may be more usual to cover liability with liability insurance. But there is no hard and fast rule and where the subject of insurance is intended to be and can properly be construed as embracing the insurable interest in relation to liability, there is no reason not to so construe it. The point is exemplified by the fourth point I make on Deepak by reference to the views of Stuart-Smith LJ on the “fire policy”. The fact that you may have an insurable interest relating to liability does not necessarily mean that that interest will be covered by a policy identified by reference to a specific subject matter. If the insurance policy is simply taken out on the plant, as one would expect from a “fire policy”, post-construction period, such a “fire policy” may not be construed to embrace the only insurable interest which Davy has. But that should be contrasted with the position where it is intended during the construction period that liability will be embraced. The final point to make on Deepak is that I would suggest that the circumstances in Deepak were such that the court may have been more reluctant than in many cases to hold that such insurable interest as Davy had was embraced by the subject of the policy. The decision is not authority for any broader proposition such as it being impossible to cover the insurable interest of liability by virtue of a policy on property if the terms of the policy embrace the insurable interest.

Summary of the principles The principles which I would suggest one gets from the authorities are as follows:- (1) It is from the terms of the policy that the subject of the insurance must be ascertained; (2) It is from all the surrounding circumstances that the nature of an insured’s insurable interest must discovered; (3) There is no hard and fast rule that because the nature of an insurable interest relates to a liability to compensate for loss, that insurable interest could only be covered by a liability policy rather than a policy insuring property or life or indeed properties or lives; (4) The question whether a policy embraces the insurable interest intended to be recovered is a question of construction. The subject or terms of the policy may be so specific as to force a court to hold that the policy has failed to cover the insurable interest, but a court will be reluctant so to hold. (5) It is not a requirement of property insurance that the insured must have a “legal or equitable” interest in the property as those terms might normally be understood. It is sufficient for a sub-contractor to have a contract that relates to the property and a potential liability for damage to the property to have an insurable interest in the property. It is sufficient under section 5 of the Marine Insurance Act for a person interested in a marine adventure to stand in a “legal or equitable relation to the adventure.” That is intended to be a broad concept…’

[628] John Lowry and Philip Rawlings, ‘Rethinking Insurable Interest’ in Sarah Worthington (Ed), Commercial Law and Commercial Practice, (Oxford, Hart Publishing, 2003) [Footnotes in the original have been omitted]

‘CONCLUSION A continuing role for insurable interest? The principles laid down in Macaura remain influential in the handful of [modern] cases directly concerned with insurable interest…On the other hand, Coleman J felt able to avoid its application in Sharp, and the courts have been willing to develop a broader conception of insurable interest where the main issue concerned subrogation rights. The subrogation cases illustrate the need for modern insurance law to accommodate the complexity of modern commercial relationships. Of course, it is tempting to see these as separate issues: cases such as Lucena and Macaura, it might be argued, involve the validity of the insurance contract, while cases such as Petrofina and National Oilwell are concerned not with the validity of the contract, but rather with the proper determination of the parties covered. Leaving aside the confusion which might result from defining insurable interest in different ways according to the particular context, the distinction seems a little forced since in both cases there is a challenge to the rights of someone claiming to be insured under a particular policy. If, for instance, a sub-contractor is not a co-insured and can, therefore, be sued by the insurer, this must surely also mean that the sub-contractor can make no claims under the policy. The acceptance by the judges that sub-contractors can be co-insureds for the purpose of defending an action brought by the insurer seems equivalent to saying that the sub-contractor’s loss is no less real than that suffered by the building’s owner, even though they have no proprietary interest. This would suggest, in our view, they should also be able to insure against such a loss. Finally, it might be suggested that the subrogation cases have arisen in particular contexts, most notably construction work, but this may simply be because of the size of the claims involved

and because the complexity of the policy may raise real doubts as to whether the policy did provide cover. The anxieties over moral hazard and wagering that prompted Lord Eldon to reach his view of insurable interest seem less relevant in the context of modern commercial practice. His test does not seem to achieve the objectives he believed it would. It does not necessarily provide any better deterrent against the moral hazard that the insured might destroy the property than the factual expectation test, indeed, it can be argued that an owner is likely to have more opportunity to damage the property. With respect to Lord Eldon’s other concern, the dangers of a wager being concealed under the guise of an insurance contract seem more remote now than they were in the early nineteenth century. Since that time the activities of insurance and wagering have become separated. In spite of criticisms, gaming has become a legitimate activity, as indicated by the Lottery and recent proposals to liberalise the gaming laws. As a consequence, the need to clothe wagering in guise of insurance has been eliminated. In so far as wagering requires regulation, this is an issue of public policy and, therefore, rightly falls within the realms of public law. The use of insurable interest as a means of regulating this activity is inappropriate since, in general, it can only be raised at the whim of the insurers, and the factors influencing them to challenge a policy are likely to be matters of commercial interest, such as the impact it will have on future business, rather than matters of public interest. Indeed, it has been raised by insurers as a means of avoiding evidential burdens. Macaura itself has been explained as a case where the insurers believed that the insured had acted fraudulently, but, because they could not prove the point, they used insurable interest as a technical defence.Further, the statutory regulatory regime governing those who conduct insurance business reduces the likelihood of insurers concluding wagering contracts. Finally,

in spite of the 1745 Act and its successors, p.p.i. contracts or honour policies, where the insurer agrees not to raise the issue of insurable interest, remain an important slice of the marine insurance industry. While it would not make good business sense for the insurer to deny liability, even though such a policy is unenforceable, it seems curious that insurance law is so out of line with commercial practice. A more fundamental point is that Lord Eldon prioritised the regulation of gaming through the use of insurable interest and failed to give proper emphasis to the competing public interest in ensuring that contracting parties perform their promises. In the final analysis, it is this that underpins the whole of contract law and might, therefore, be considered as of greater importance. Modern insurers can frame coverage on the basis of a proposal in which they can ask such questions about the relationship between the proposer and the property as they think relevant to their decision as to whether or not to accept the risk. Moreover, the duty of disclosure, which places the insurer in an advantageous position when compared with parties in non-insurance contracts, makes it difficult to justify a situation in which the insurer can freely enter into the contract on the basis of full disclosure and still deny liability because of a lack of insurable interest. The implications of the lack of litigation directly on insurable interest since Macaura might be that the insurers accept the logic of this argument, or that the commercial implications of refusing to pay out would, presumably, be the same as those facing the bookmaker who failed to pay a winning bet. Although some commentators have expressed the view that the courts are occasionally prepared to recognise that insurers may waive the requirement of insurable interest, it is our view that such a defence is not available to policyholders given that traditionally UK judges view the requirement as rooted in public policy. In those cases where policies were enforced without insurable interest, such as

Prudential Staff Union v Hall [1947] KB 685, the courts recognised that on the facts the issue of wagering did not arise. It could also be argued that the courts are rightly ill disposed towards allowing lack of insurable interest to be pleaded where insurers are fully cognisant of the risk covered by the policy. Recent support for this contention can be found in Cepheus Shipping, in which Mance J observed: “the present policy is not on its face one which the parties made for other than ordinary business reasons; it does not bear the hallmarks of wagering or the like. If underwriters make a contract in deliberate terms which covers their assured in respect of a specific situation, a Court is likely to hesitate before accepting a defence of lack of insurable interest.” If the policy considerations that underpinned Lord Eldon’s definition are no longer relevant, then one is left to wonder whether the requirement of insurable interest serves any useful purpose. It has the potential to allow the insurer to defeat the reasonable expectations of the parties and this encourages the judges to complicate the law by devising exceptions to the requirement as we have seen in the cases on subrogation. Where a party stands to suffer a pecuniary loss it seems illogical to argue that the desire to insure against such loss is tantamount to wagering. Parliament has acknowledged the difficulties caused by the requirement by permitting third parties to sue insurers directly in certain circumstances, notwithstanding the absence of insurable interest. One is left to wonder what it adds to the principle of indemnity under which, in general, the claimant is compensated for the pecuniary loss suffered. In Macaura the insurers were unable to substantiate their suspicion of fraud and this led them to raise the lack of insurable interest. As has been noted, the House of Lords also identified the difficulties inherent in assessing the loss suffered. It seems

wrong to allow the requirement to be used as a technical defence in circumstances which bear no relation to its original policy objectives. Where fraud is alleged it should be proved. An insurer always has the option of refusing to underwrite a risk which is difficult to assess, such as where a shareholder seeks to insure the assets of a company. The continuing insistence on requiring insurable interest — whatever definition is adopted — harks back to a time when policy issues dictated that this should be a precondition to the validity of the insurance contract. Once those policy arguments are removed, the justification for the requirement disappears. Even if, as we have shown, a process of assimilation of the factual expectation test is underway, the obvious question remains, is there a role for insurable interest? It is our view that the principle of indemnity, which prohibits recovery to those who cannot establish proof of loss, is in itself sufficient to render the requirement redundant.’

[629] Sir Jonathan Mance, ‘Commentary on Rethinking Insurable Interest’ in Sarah Worthington (ed), Commercial Law and Commercial Practice, (Oxford, Hart Publishing, 2003) ‘John Lowry and Philip Rawlings set out to demonstrate with clarity and force that a combination of two House of Lords decisions (Lucena v Craufurd (1802) 2 B&P (NR) 269 and Macaura v Northern Assurance Co Ltd [1925] AC 619) and the Marine Insurance Act 1906 paints English law into the corner of an ancient field, but that this has not deterred English judges of a more modern generation from adopting an expanded view of insurable interest in adjacent fields. Adrian Hamilton, who was, as you have just heard, counsel in Petrofina v Magnaload [1983] 2 Ll R 91, ought,

incidentally, to receive some old-fashioned prize money for his role in the latter context. The rules governing insurable interest are certainly (a) technical, because of the various different statutory regimes, (b) doubtfully necessary in many cases, because of the principle that an insured can only recover an indemnity and (c) contrary also in spirit in other cases to the principle which allows valued policies covering sums considerably in excess of the actual loss. Do the objections to the present position identified by Lowry and Rawlings matter? As they observe, it is not in insurers’ insurance interests to raise too many points on insurable interest. Even in cases where they might be motivated to do so by their general view of the merits or lack of merits of a claim, insurers’ general commercial interests may operate as some restraint. Attempts to insure by shareholders may not today be as frequent as in the past. But key-man or woman policies, taken out by companies in respect of their director or other leading spirit’s lives or health, are a reverse image, yielding good premiums which insurers will not lightly imperil. The 1906 Act and the general principles of insurance law governing disclosure and warranty offer examples of apparent inequity, which have been roundly criticised but impervious to reform. The doctrine of insurable interest is a more obscure problem, the practical implications of which are less obviously prejudicial. And is the common law cause quite as lost as Lowry and Rawlings suggest? First, of course, the House of Lords can always override or qualify its previous decisions. But, secondly, it is worth taking a further look at existing authority. In Moran Galloway & Co v Uzzielli [1905] 2 KB 555, Walton J gave a judgment which the authors castigate as contradictory. But in reality he was affirming first that it was unnecessary to have a legal or equitable interest in the property insured, since second it also sufficed if there was a

legal or equitable interest in some property that was “dependant” on the safety of the thing exposed to the insured risks. That, it seems to me, may leave some scope for development. Even section 5(2) of the Marine Insurance Act has some openness of texture, since it accepts that it is sufficient to stand in any legal or equitable relation to an adventure and not merely to any insurable property at risk therein. It is relevant in this context to note Wilson v Jones (1867) LR 2 Ex 139. It is part of the history of the great ship built by that next greatest Britain, Brunel, launched as the Leviathan and better known as the Great Eastern. Taken out of service as a passenger carrier within a few years of her maiden voyage, she was in 1865 chartered by the Atlantic Telegraph Company to lay the second transatlantic cable; the previous cable having been too weak and having broken after only three weeks (and 723 messages). The Great Eastern’s first attempt in August 1865 ended in a broken cable and the litigation in Wilson v Jones. The breakage was graphically described in a letter from Sir Daniel Gooch, who was on board. He was a friend of Brunel and now owned the Great Eastern. To back the venture he had invested the huge sum of £¼ million in “cable stock” (presumably issued by Atlantic Telegraph Company to finance the venture). Half the cable remained after the breakage at the bottom of the sea. As to the litigation resulting from the breakage, the terms of the law report are both more prosaic and more obscure. The plaintiff was a very small shareholder in Atlantic Telegraph. He took out a marine policy in ordinary form, on the ship, &, goods and merchandise for so much as concern the assured, valued at £200, say on twenty shares, valued at £10 per share. The Court of Exchequer Chamber upheld the claim, accepting that the plaintiff as shareholder could have no insurable interest in the cable, but describing the subject matter insured as being his interest in the adventure

(Willes J at page 149) or his interest in the laying of the cable on that particular voyage (Blackburn J at page 152). We move to a non-marine context, and what Lowry and Rawlings clearly regard as the dead-hand of Macaura v Northern Assurance Co Ltd [1925] AC 619. But it is to be noted that in that very authority, the House of Lords considered Wilson v Jones; and they did not reject or overrule it, but explained it as a case “where the insurance was upon the adventure in which the shareholder had an interest, and not upon the cable in which he had none” (Lord Buckmaster at page 628) or was a case where although “the policy described the subject-matter of the insurance in a very obscure manner, it was held that the shareholder insured had an interest that he could insure in the profits of the adventure so described, but it was expressly stated that he had no such interest in his shares in the company” (Lord Sumner, pages 630–1, with whom Lord Wrenbury agreed at page 633). This shows two things at least. First, courts need not be too rigid in ascertaining the interest by reference to the literal language of the policy. A certain flexibility, to find and uphold an insurable interest, may be permissible. Secondly that insurable interest may in some circumstances lie in the existence of an “adventure” in which the insured is engaged and by which he aims to profit. If that is right, then very broad coverage can be sought and issued, since there are in law virtually no limits to the perils or risks that may be insured. It has been suggested that the only admissible relationship to any such adventures is one which involves or arises out of some proprietary or contractual interest in it. So it is said that the shareholding in Wilson v Jones was critical. But that is hard to square with Lord Sumner’s words. Further, if a rower sets out to row the Atlantic with the prospect of great financial reward if he succeeds, and he decides to insure the success of the adventure against

storms, can it really matter whether he owns or has contracted for the use of his boat or has been lent it free? Is the swimmer who sets out to swim across the Channel unable to insure against storms, because she uses no property? And what about general loss of profits insurances, as Clarke on Insurance Law points out? Must the concert pianist who wishes to cover his loss of profits confine himself to personal injury policies, or try to attach his interest in his profit-making abilities to his piano? Surely this cannot even represent the current common law, and Wilson v Jones suggests a chink of light in the otherwise impenetrable obstacles of prior authority. Finally, you will be glad to hear that the Great Eastern, a notoriously unlucky vessel, did in 1866 return, this time successfully, to the fray. A cable was laid from Greenwich to Hearts Content, Newfoundland in June–July, and for good measure in August the Great Eastern was able to recover the lost half of the 1865 cable from the ocean bed. But this was only done after a new company, the Anglo American Telegraph Company had been formed, so that Mr Wilson still needed his success in the litigation in Wilson v Jones, and English law may still perhaps benefit by it too.’

6.4 Waiver of Insurable Interest English decisions have left open the question of whether an insurer can waive insurable interest. On balance it would seem that such a defence is not available to insureds given that the requirement is rooted in public policy (see M Clarke, The Law of Insurance Contracts, para 4.1.D). Most US jurisdictions follow that view (see, for example, Beard v American Agency Life Ins Co 550 A2d 677 (Md 1988)); and Farm Bureau Mutual Insurance Co v Glover 616 S W 2d 755 (1981)). There are, however, examples from the case-law

where policies were enforced despite the absence of insurable interest; although it is noteworthy that the issue of wagering did not arise on the facts of the cases: [630] Prudential Staff Union v Hall [1947] KB 685 [The insured, an employees union, took out a policy with Lloyd’s insuring against loss the premium monies collected by their members who were agents of their employers. The union received 3s (15p) from each of its members in respect of the insurance premiums. The underwriters had previously met the union’s claims made on behalf of its members they repudiated a particular claim made in respect of a burglary. Although the insured lacked insurable interest, nevertheless it was held that the policy was enforceable by the union].

Morris J: ‘In my judgment, the alleged loss is one in relation to which the union are entitled to sue, because the defendant contracted to pay the union. No doubt the union would regard themselves as trustees for the particular members of any amount recovered, so that those members could pay such amount in settlement of any claims made on them by their employers for moneys received or held on their behalf: see Vandepitte v Preferred Accident Insurance Corporation of New York [below, [632]].’ Notes: 1. By enlisting the trust device Morris J was able to circumvent any element of wagering thus avoiding any violation of public policy considerations. See also, Thomas v National Farmers’ Union Mutual Insurance Society Ltd [1961] 1 WLR 386, Diplock J. 2. It has been seen that an insured with little or no interest can effect insurance for the benefit of a third party (see, for example, Waters v Monarch Life and

Fire Assurance Co (above, [622]) and Tomlinson (Hauliers) Ltd v Hepburn (above, [623]). In this context there is a need to distinguish between joint, composite and pervasive interests. While joint insurance covers joint owners of property (a typical example would be a policy on the matrimonial home taken out by spouses) and composite insurance provides cover for two or more persons interested severally, pervasive interest is a hybrid of the two (see Petrofina (UK) Ltd v Magnaload Ltd (above, [624]) and Co-operative Retail Services Ltd v Taylor Young Partnership (above). 3. It is particularly common in motor insurance for an insured to effect cover on his or her own behalf together with cover for those who might also drive the vehicle such as a spouse, child or sibling. The question again arises as to whether or not such an insured possesses insurable interest in the potential liability of other named drivers.

[631] Williams v Baltic Insurance Association of London [1924] 2 KB 282 [The insured, Mr Bransby Williams, effected a motor policy on his car which covered liability to third parties for personal injuries caused by the use of the vehicle. The policy also contained a clause which stated that the insurers would indemnify the insured against “all sums for which the insured (or any licensed personal friend or relative of the insured while driving the car with the insured’s general knowledge and consent) shall become legally liable in compensation for loss of life or accidental bodily injury caused to any person” (cl 2). The claimant’s

sister, Miss Bransby Williams, while driving the car with his consent, was involved in an accident which resulted in her being liable to pay damages for injuries caused to third parties]. Roche J: ‘On the question of interest Mr Claughton Scott [counsel for the insured] said that Mr Bransby Williams was interested in Miss Bransby Williams’s immunity from claims, and that she was herself interested in her protection against claims; further that she was interested as the driver of the motor car in respect of the motor car itself. I do not decide these points, but I think there is a great deal in them. With regard to the last point it will be noted that in the Marine Insurance Act, 1906, a person is interested in a marine adventure who (inter alia) may incur liability in respect thereof… The general argument that Mr Bransby Williams cannot recover for Miss Bransby Williams because the latter cannot recover for herself, is based upon this, that the insured is Mr Bransby Williams. That, I think, is begging the question. Mr Bransby Williams is the insured in the sense that he is the person who effected the insurance, but it is an insurance for himself and the other persons mentioned in cl 2, and, accordingly, the company’s contract is to indemnify all such persons in the event of those things happening against which the insurance is effected. The principle of Waters v Monarch Fire and Life Assurance Co [above, [622]] in that matter also applies here.’

7 The Doctrine of Insurable Interest in Life Assurance 7.1 Introduction In the previous chapter we saw that wagering by insurance was viewed as a pernicious practice and that this resulted in a series of statutes aimed at curbing the enforcement of insurance contracts where the insured lacked insurable interest. Using insurance as a subterfuge for wagering was by no means restricted to property insurance. In life insurance it was not uncommon to insure the lives of those accused of capital offences such as murder. The nature of the wager related to the odds of whether the accused person would be convicted and executed. It was also common practice to insure the lives of prominent people, particularly where such a person had been reported as suffering from a serious illness: [701] Thomas Mortimer, Every Man His Own Broker (London, WJ & J Richardson, 1801)

‘Another manner of spending the vacation formerly was, in insuring on the lives of such unfortunate gentlemen, as might happen to stand accountable to their country for misconduct. I am not willing to disturb the ashes of the dead, or I could give an instance of this cruel pastime, the parallel of which is not to be met within the history of any civilised nation: but I hope we shall hear no more of such detestable gaming… A practice likewise prevailed of insuring the lives of wellknown personages, as soon as a paragraph appeared in the newspapers announcing them to be dangerously ill. The insurance rose in proportion as intelligence could be procured from the servants, or from any of the faculty attending, that the patient was in great danger. This inhuman sport affected the minds of men depressed by long illness; for when such persons, casting an eye over a newspaper for amusement, saw that their lives had been insured in the Alley…they despaired of all hopes, and thus their dissolution was hastened.’

[702] Gilbert v Sykes (1812) 16 East 150 [Having discussed the probability of Napoleon Bonaparte’s assassination over dinner, the claimant entered into a wager whereby he agreed to pay the defendant one hundred guineas on 31 May 1802 in return for which the defendant agreed to pay him one guinea a day so long as Napoleon Bonaparte lived. The daily payments were met for some eighteen months but on the 25 December 1804 the defendant stopped paying. The plaintiff sued claiming £2,296 being the sum outstanding for non-payment of the instalments].

Lord Ellenborough CJ: ‘where the subject-matter of the wager has a tendency injurious to the interests of mankind, I have no doubt in saying that it ought not to be sustained…I think that an action should not be countenanced upon a subject in which the parties had not only no interest other than what they created to themselves by the bet, but the public have no interest to restrain it. Therefore founding my opinion upon all the circumstances in evidence in this case, I consider it as a wager against public policy and of immoral tendency…’ Le Blanc J: ‘It has been often lamented that actions upon idle wagers should ever have been entertained in Courts of Justice: the practice seems to have prevailed before that full consideration of the subject which has been had in modern times…and it is now clearly settled that the subject-matter of a wager must at least be perfectly innocent in itself, and must not tend to immorality or impolicy. Then, can a wager upon the life of a person, whether enemy or friend, founded upon the probability of its terminating by assassination or other violent death, be said to be innocent in itself? Such a wager does not come within the range of any of those cases where wagers have been sustained…in my opinion it is both impolitic and immoral to bet concerning the life of a Sovereign, whether he shall come to his death by assassination or other violent means.’ Bayley J: ‘The discussion which has been had of this case has strongly illustrated the inconvenience of countenancing idle wagers in Courts of Justice: it occupies the time of the Court, and diverts their attention from causes of real interest and concern to the suitors: and I think it would be a good rule to postpone the trial of every action upon idle wagers till the Court had nothing else to attend to. This is the case of a

mere idle wager, in which the parties had no particular concern. It was induced by a conversation, not upon the probability of the person’s death within a given time, in the course of nature, but by assassination or other violent means: the amount of the sum given shews that his death by violent means was in the contemplation of the wagering parties; and that, I think, for the reasons which have been stated, makes the wager both immoral and impolitic’.

Note: As we saw in relation to property insurance, wagering aside, the policy underlying insurable interest was aimed at addressing the moral hazard that those who lack interest might succomb to the temptation to bring about the loss. In the context of life insurance, the anxiety was to prevent the wilful destruction of life. A modern and colourful illustration is afforded by the facts of an American decision: [703] Rubenstein v Mutual Life Insurance Co of New York United States District Court, Eastern District of Louisiana 584 F Supp 272 (1984) [The facts appear from the judgment]. Charles Schwartz Jr., District Judge: ‘Plaintiff, Alan M. (“Mike”) Rubenstein, instituted this action to recover the proceeds of a $240,000 credit life insurance policy issued by defendant, The Mutual Life Insurance Company of New York (MONY), insuring the life of Harold J Connor, Jr. Connor died on 6 November 1979. Plaintiff is the beneficiary and owner of said policy; MONY claims that

plaintiff is not entitled to recovery under the policy for reasons that are the subject of this suit, and refunded to plaintiff the premiums paid by plaintiff. Plaintiff is a resident of Louisiana; defendant is a corporation incorporated and domiciled in New York, authorised to do and doing business in Louisiana. Prior to, during, and after July 1979, plaintiff was employed as a fulltime owner and operator of a taxi cab associated with the United Cab Company of New Orleans. After attending a local seminar, he purportedly became interested in starting and developing “TV Journal”…to be circulated free of charge in St Tammany Parish. Revenues were to be derived solely from paid advertisements contained in the publication. In late July 1979, Connor contacted plaintiff through the Louisiana Unemployment Commission in Slidell, where plaintiff had placed a notice requesting assistance in developing and operating the “TV Journal.” On 7 August 1979, shortly after their initial meeting, plaintiff and Connor entered into a partnership agreement making Connor a 25 per cent partner in the “TV Journal” business until 1 January 1980; thereafter, plaintiff would “grant” Connor a franchise for the publication of a tabloid in the St Tammany Parish area to be entitled “TV Journal.” Under the franchise aspect of the agreement, Connor was required to pay plaintiff $1,000 per month for 20 years beginning on 1 February 1980, but could terminate the agreement at any time upon 60 days notice without penalty. Also on 7 August 1979, plaintiff and Connor met with Earl Moreau, a MONY agent, regarding life insurance on Connor. Based on discussions between plaintiff, Connor and Moreau concerning plaintiff’s newly established business relationship with Connor, Moreau recommended, and plaintiff applied for, a $240,000 credit life insurance policy [covering the risk of a debtor dying before repaying a debt to the insured creditor] on Connor’s life, who was then 23 years old. As of the date of application, Connor had done

little if any work for the “TV Journal” business; and no edition of it had been published, and no advertisements sold. No evidence was introduced to demonstrate the need for this fledgling and undercapitalised business to expend its limited resources for insurance on the life of an apparently healthy 23 year old man. In providing information for the insurance application, plaintiff and Connor represented that Connor’s annual income at the time of the application was $26,000 when in fact Connor’s sole source of income was the “TV Journal” business, from, which he received approximately $100 to $150 a week. Had MONY known Connor’s actual income, it would not have issued the policy herein since an insured earning such limited income has no reasonable prospect of repaying a debt of $1,000 per month for 20 years without the life insurance… The evidence further establishes that when plaintiff applied for the insurance policy, and when Connor died on 6 November 1979, Connor was not at all indebted to plaintiff because Connor was not obligated to begin making payments to plaintiff until 1 February 1980. Based on the information before it, MONY agreed to issue the policy on 28 September 1979; it was thereafter delivered to plaintiff on 6 October 1979. According to plaintiff’s testimony, Connor was to do all the work in preparing the “TV Journal” for publication, while plaintiff was to provide the capital. However, Connor’s education was limited to high school, and prior to 7 August 1979, he had no experience in publishing and only limited experience in sales, having worked for approximately two months without success as a furniture salesman, according to Paula Andrus, Connor’s girlfriend at the time. Ms Andrus also attested to Connor’s inability to balance his own checking account, further evidence of his lack of business skill.

Plaintiff, too, had no prior experience in publishing or in selling advertisements, his only sales experience of any nature having occurred “years” ago, by his own admission. Plaintiff did observe the operations of “TV Tempo” for the purpose of learning the operations of such a weekly, and prior to 7 August 1979, had taken some preliminary steps in furtherance of the “TV Journal” (eg. contacting printers, obtaining proofs and TV listings, and figuring possible advertising rates). But, after that date, plaintiff’s involvement in the operations of the “TV Journal” was nominal at best; he testified that he did not even know whether Connor had sold a single advertisement, and plaintiff himself had made only a few calls for that purpose. Plaintiff also stated that he was not aware of what bills Connor was paying, or how much he was paying Connor in salary. As further evidence of his own lack of business acumen, plaintiff explained the origin of the provision requiring Connor to pay him $1,000 per month beginning 1 February 1980, by saying that they “both came up with the idea of $1,000,” with no further justification for the projection. Regarding the financing of “TV Journal,” plaintiff explained that he bought some furniture for the office, which was located in Connor’s apartment, and that he paid Connor’s salary and “whatever” else Connor needed. The evidence indicates, however, that at most $5,000 was available as of late August, 1979, to develop the “TV Journal” until it became profitable or generated significant advertising revenues. Most of the $5,000 apparently originated from a $5,433 loan issued by the Bunkie Bank & Trust Company on 22 August 1979, for which Connor signed the note and plaintiff provided the collateral. Of the $5,433, however, $1,400 was used by plaintiff to pay off a previous personal loan from Bunkie Bank & Trust, and $1,000 was given to Connor for his personal use. Disposition of the remaining $3,000 is unclear, although it appears that the money was

deposited in plaintiff’s personal account with the Hibernia National Bank, which account he used to pay Connor’s salary. This account showed a balance of $1,246 on 7 November 1979, which was immediately before Connor had planned to print the first issue. Plaintiff’s only other account was one he maintained with Bunkie Bank & Trust from November 1976 to November 1979. It had an average balance of $1,500 to $1,800 before it was closed. The “TV Journal” account at the Fidelity Bank & Trust Company shows a balance that was overdrawn twice in a two month period… In addition, the failure of “TV Journal” to presell any advertisements or to obtain any advertising contracts further impaired any likelihood of success; without presold advertisements, the business would have incurred substantial losses during its first six months, from which it would have had little chance of recovering. Given this slim chance of reaching the breakeven point, Connor would have had no realistic possibility of being able to cover the $1,000 monthly payment to plaintiff. The bizarre circumstances surrounding the tragic death of Harold J Connor, Jr, even after lengthy testimony from five witnesses who were present when Connor was shot, are still largely in dispute and somewhat irreconcilable. What was established conclusively at the trial was as follows: Connor was part of a deer hunting party that included plaintiff, plaintiff’s stepchildren, David and Darryl Perry, and the Perrys’ first cousin, David Kenney. They left the New Orleans area on 5 November 1979, and arrived at plaintiff’s parents’ home in Bunkie later that day. Thereafter, plaintiff’s brother, Larry Rubenstein, and a friend of his, Michael Fournier, also arrived at the home of plaintiff’s parents. Plaintiff claims that he had no prior notice of his brother’s and Fournier’s visit. The latter joined the hunting party early the following morning. The group travelled in plaintiff’s car on a dirt road

surrounded by woods to a location selected the previous evening when plaintiff visited his uncle and cousin. When the party arrived at the location, plaintiff distributed the firearms, ammunition, and orange hunting vests to each member of the group. Thereafter, Kenney locked the car keys inside the car, and the group searched for wire with which to open the door lock. Soon after Connor was able to open the front door on the passenger side, Foumier, who was standing less than 10 feet behind Connor, discharged his gun, a single shot, 12 – gauge shotgun. The pellets struck Connor in the back, slightly above the waist, and travelled generally in a lateral path through his body. Fournier claims that the gun discharged when he tripped, and Darryl Perry, in corroborating his testimony, claims that the gun discharged about when the butt was close to the ground and while the barrel was pointed diagonally upward in the direction of Connor. This testimony, however, was flatly contradicted by the forensic scientist and pathologist, who concluded that in view of the lateral path of the pellets through Connor’s body above his waist, the barrel of the gun must have been parallel (horizontal) to the ground and at waist level at the time of discharge. Further, because of its safety device, in order for the gun to have been discharged, it must have been loaded, cocked, and the trigger pulled. The firing pin could not have been activated just by the gun striking the ground. The testimony of the witnesses raises more questions than it answered, in particular: why did Connor go deer hunting when according to his mother, girlfriend and cousin, he had never been hunting before and was disgusted by the idea of killing animals, and did not pack the proper clothing? And why did Fournier load his gun, cock it, have his finger on the trigger, and have it pointed at Connor? We conclude that examined in the light most favorable to the plaintiff, his handing a shotgun and ammunition to an individual who was, according to the plaintiff, previously unknown to him,

and who was, it was later learned, a convicted felon then on probation and prohibited from carrying firearms, constitutes conduct falling well below the standard of care required of a reasonable person in possession of firearms. Examining the evidence not in the light most favorable to plaintiff but instead with the slightest circumspection leads to the distasteful conclusion that Harold J Connor, Jr. was killed under highly suspicious circumstances, circumstances that suggest something far more sinister than a mere “accident.” CONCLUSIONS OF LAW …Defendant interposes three separate and independent defenses to plaintiff’s claim that he is entitled to recover under the $240,000 credit insurance policy insuring the life of Harold J Connor, Jr: (1) that defendant was induced to execute the policy by material misrepresentations made with the intent to deceive the insurer; (2) that plaintiff as the beneficiary lacks an insurable interest in the life of the insured; and (3) that plaintiff was culpably negligent in contributing to the death of the insured, and that such negligence bars his recovery under the policy. For the purposes of this decision, we need only consider defendant’s first two defenses, and make no ruling on the third. Under Louisiana law, a life or health insurance policy is null and void if the insurer is induced to execute the policy by misrepresentations in the application that were made with the intent to deceive and if the misrepresentations materially affected the insurer’s decision to accept the risk or increased the hazard assumed by the insurer… Consistent with the foregoing findings, wherein we found that plaintiff and Connor misrepresented Connor’s salary and failed to disclose the termination provision; that they knew of the falsity and the materiality of their misrepresentations; and that each of said

misrepresentations materially affected the insurer’s decision to accept the risk; we find that the insurance policy in question is null and void under La RS 22:619(B). We further conclude that each of the misrepresentations constitutes a separate and independent ground for invalidating the insurance policy under said statutory provision [as to nondisclosure and misrepresentation see chapter 6]. Louisiana law also requires that a beneficiary who procures an insurance policy upon the life of another have an insurable interest in the life of the insured. La RS 22:613(A). The absence of any insurable interest on the part of the beneficiary who procures the policy invalidates the policy, and the insurer’s only liability is to return the premiums paid…The beneficiary has the burden of proving the existence of the insurable interest. A beneficiary who is not related by blood or marriage to the insured does not have an insurable interest unless he has a reasonable expectation of pecuniary gain from the continued life of the insured, or reasonable expectation of sustaining loss from his death… Where the beneficiary’s insurable interest is a debt allegedly owed by the insured, as is herein claimed, the amount of the life insurance at the time the policy was written and at the time of the insured’s death must be proportionate to the debt actually owed by the insured; if the value of the life insurance is grossly disproportionate to the amount actually owed, the beneficiary lacks an insurable interest, and the policy is null and void…Since we earlier held that Connor was not indebted to plaintiff either when the policy was written or when he died, the amount of the insurance is grossly disproportionate to the amount of the debt. Even if we consider the amount that Connor could have owed under the terms of the partnership agreement — $2,000 — this too is far exceeded by the face value of the policy. Accordingly, we conclude that plaintiff lacks an insurable interest in the policy herein considered.

Should we characterise the beneficiary’s expectation as a pecuniary gain arising from his business partnership with the insured, rather than as a debt arising from their relationship, our findings of fact lead to only one reasonable conclusion: that an expected pecuniary advantage of $240,000 in profits over 20 years derived from “TV Journal” is grossly disproportionate to the amount Connor could have paid plaintiff on a monthly basis given the inexperience of Connor and plaintiff and the vast undercapitalisation of the venture. We therefore hold that plaintiff lacks an insurable interest under this theory too… Because an insurable interest is required by law in order to protect the safety of the public by preventing anyone from acquiring a greater interest in another person’s death than in his continued life, the parties cannot, even by solemn contract, create insurance without an insurable interest; further, the insurance company cannot waive or be estopped from asserting lack of insurable interest by its conduct in issuing the policy… Considering the foregoing, we hold that the insurance policy from which plaintiff claims he is entitled to recover is null and void, and thus that his claim against defendant is hereby dismissed.’

Note: It was commented in chapter 6 that the Life Assurance Act 1774 sought to address both the moral hazard and the societal waste caused by the prevalence of wagering under the guise of life insurance by requiring the proposer to have insurable interest in the life insured [the relevant provisions are given in chapter 6 but for ease of reference they are again reproduced here]:

[704] Life Assurance Act 1774 (14 Geo III, c 48) Preamble An Act for regulating Insurance upon Lives, and for prohibiting all such Insurances except in cases where the Persons insuring shall have an interest in the Life or Death of the Persons insured. 1. No insurance to be made on lives, etc., by persons having no interest, etc Whereas it hath been found by experience that the making insurances on lives or other events wherein the assured shall have no interest hath introduced a mischievous kind of gaming: For remedy whereof, be it enacted by the King’s most excellent Majesty, by and with the advice and consent of the lords spiritual and temporal, the commons, in this present Parliament assembled, and by the authority of the same, that from and after the passing of this Act no insurance shall be made by any person or persons, bodies politick or corporate, on the life or lives of any person, or persons, or on any other event or events whatsoever, wherein the person or persons for whose use, benefit, or on whose account such policy or policies shall have not interest, or by way of gaming or wagering: and that every assurance made contrary to the true intent and meaning hereof shall be null and void to all intents and purposes whatsoever. … 3. How much may be recovered where the insured hath interest in lives And…in all cases where the insured hath interest in such life or lives, event or events, no greater sum shall be recovered or received from the insurer or insurers than the amount of

value of the interest of the insured in such life or lives, or other event or events.

7.2 Time When Interest Must Be Shown If section 1 and section 3 of the 1774 Act are read together, it might be assumed that an insured would need to demonstrate interest at the time of effecting the policy and at the time of the loss (as is the case with indemnity insurance; see Godsall v Boldero (1807) 9 East 72 discussed by Merkin, below [706]). However, it was held in Dalby that interest must be shown at the time of effecting the policy only: [705] Dalby v The India and London Assurance Co (1854) 15 CB 365

Life

[The life of the Duke of Cambridge had been insured with Dalby’s company, Anchor Life, for £3,000 under four policies. The company reinsured the risk to the extent of £1,000 with the defendants. When the insured, Wright, cancelled the policies Anchor nevertheless maintained the reinsurance policy until the Duke’s death at which time Dalby claimed. The defendants refused to pay arguing that Dalby’s interest in the Duke’s life ceased when the insured cancelled the policies. It was held that life insurance is not a contract of indemnity and the requirement of insurable interest need only be shown at the date of effecting the policy]. Parke B:

‘It may be conceded for the purpose of the present argument that the [cancellation by Wright]…totally put an end to that interest which the Anchor Company had when the policy was effected, and in respect of which it was effected: and that, at the time of the Duke’s death, and up to the commencement of the suit, the plaintiff had no interest whatever… This raises the very important question, whether, under these circumstances, the assurance was void, and nothing could be recovered thereon… The contract commonly called life assurance, when properly considered, is a mere contract to pay a certain sum of money on the death of a person, in consideration of the due payment of a certain annuity for his life, — the amount of the annuity being calculated, in the first instance, according to the probable duration of the life: and, when once fixed, it is constant and invariable. The stipulated amount of annuity is to be uniformly paid on one side, and the sum to be paid in the event of death is always (except when bonuses have been given by prosperous offices) the same, on the other. This species of insurance in no way resembles a contract of indemnity… The statute [the Life Assurance Act 1774 (14 Geo III, c 48)] recites, that the making insurances on lives and other events wherein the assured shall have no interest, hath introduced a mischievous kind of gaming: and, for the remedy thereof, it enacts “that no insurance shall be made by any one on the life or lives of any person or persons, or on any other events whatsoever, wherein the person or persons for whose use and benefit, or on whose account, such policy shall be made, shall have no interest, or by way of gaining or wagering; and that every assurance made contrary to the true intent and meaning hereof shall be null and void to all intents and purposes whatsoever.” As the Anchor Assurance Company had unquestionably an interest in the continuance of the life of the Duke of

Cambridge, — and that to the amount, of £1,000, because they had bound themselves to pay a sum of £1,000 to Mr Wright on that event, — the policy effected by them with the defendants was certainly legal and valid, and the plaintiff, without the slightest doubt, could have recovered the full amount, if there were no other provisions in the Act. This contract is good at common law, and certainly not avoided by the first section of the 14 Geo III c 48. This section, it is to be observed, does not provide for any particular amount of interest. According to it, if there was any interest, however small, the policy would not be avoided. The question arises on the third clause. It is as follows [the judge recited the provision]… Now, what is the meaning of this provision? On the part of the plaintiff, it is said, it means, only, that, in all cases in which the party insuring has an interest when he effects the policy, his right to recover and receive is to be limited to that amount; otherwise, under colour of a small interest, a wagering policy might be made to a large amount, — as it might if the first clause stood alone. The right to recover, therefore, is limited to the amount of the interest at the time of effecting the policy. Upon that value, the assured must have the amount of premium calculated: if he states it truly, no difficulty can occur: he pays in the annuity for life the fair value of the sum payable at death. If he misrepresents, by overrating the value of the interest, it is his own fault, in paying more in the way of annuity than he ought; and he can recover only the true value of the interest in respect of which he effected the policy: but that value he can recover. Thus, the liability of the assurer becomes constant and uniform, to pay an unvarying sum on the death of the cestui que vie, in consideration of an unvarying and uniform premium paid by the assured. The bargain is fixed as to the amount on both sides.

This construction is effected by reading the word “hath” as referring to the time of effecting the policy. By the first section, the assured is prohibited from effecting an insurance on a life or on an event wherein he “shall have” no interest, — that is, at the time of assuring: and then the third section requires that he shall cover only the interest that “hath.” If he has an interest when the policy is made he is not wagering or gaming and the prohibition of the statute does not apply to his case. Had the third section provided that no more than the amount or value of the interest should be insured, a question might have been raised, whether, if the insurance had been for a larger amount, the whole would not have been void: but the prohibition to recover or receive more than that amount obviates any difficulty on that head. On the other hand, the defendants contend that the meaning of this clause is, that the assured shall recover no more than the value of the interest which he has at the time of the recovery, or receive more than its value at the time of the receipt. The words must be altered materially, to limit the sum to be recovered to the value at the time of the death, or (if payable at a time after death) when the cause of action accrues. But there is the most serious objection to any of these constructions. It is, that the written contract, which, for the reasons given before, is not a wagering contract, but a valid one, permitted by the statute, and very clear in its language, is by this mode of construction completely altered in its terms and effect. It is no longer a contract to pay a certain sum as the value of a then existing interest, in the event of death, in consideration of a fixed annuity calculated with reference to that sum ; but a contract to pay, — contrary to its express words, — a varying sum, according to the alteration of the value of that interest at the time of the death, or the accrual of the cause of action, or the time of

the verdict, or execution; and yet the price, or the premium to be paid, is fixed, calculated on the original fixed value, and is unvarying ; so that the assured is obliged to pay a certain premium every year, calculated on the value of his interest at the time of the policy, in order to have a right to recover an uncertain sum, viz, that which happens to be the value of the interest at the time of the death, or afterwards, or at the time of the verdict. He has not, therefore, a sum certain, which he stipulated for and bought with a certain annuity; but it may be a much less sum, or even none at all. This seems to us so contrary to justice and fair dealing and common honesty, that this construction cannot, we think, be put upon this section. We should, therefore, have no hesitation, if the question were res integra, in putting the much more reasonable construction on the statute, that, if there is an interest at the time of the policy, it is not a wagering policy, and that the true value of that interest may be recovered, in exact conformity with the words of the contract itself. The only effect of the statute, is, to make the assured value his interest at its true amount when he makes the contract.’

Note: The decision in Dalby has generated considerable academic debate. The issue is what interest did Anchor have in the Duke of Cambridge’s life once the policies had been cancelled. [706] R Merkin “Gambling by Insurance — A Study of the Life Assurance Act 1774” (1980) 9 Anglo-American LR 331

‘1 — The Need for Insurable Interest (1) The reasons for requiring insurable interest The paramount purpose of the 1774 act was to stamp out gambling hidden by a notional insurance. There were three factors behind this. In the first place, there was a growing objection in this period to gambling in all its forms because of the social consequences that it inevitably produced. Blackstone expressed his outrage thus: “Taken in any light, it is an offence of the most alarming nature; tending by necessary consequence to promote public idleness, theft and debauchery among those of a lower class; and among persons of a superior rank, it hath been attended with the sudden ruin and desolation of ancient and opulent families, an abandoned prostitution of every principle of honour and virtue, and too often hath ended in self-murder.” Similar views in a more modem setting have been expounded by Paterson [“Insurable Interest in Life”, (1918) Columbia LR 381]: “…a sense of antagonism is aroused in a community of workers against persons who obtain a means of livelihood without participating in the machinery of social or economic production or distribution — in short, against ‘social slackers’. More specifically, unearned gains lead to idleness, and the wagerer becomes a social parasite. On the moral side, idleness leads to vice; and the impoverishment of the loser entails misery, and, in its consequence, crime.” Secondly, the particular practice of wagering on lives brought in its wake an unfortunate consequence: “The duration of lives of persons believed to be on their death bed was a common hazard, and the dissolution of

persons, who saw themselves insured in the public papers at 90%, was, not unlikely, hastened by such announcement [Welford, Insurance Guide and Handbook (1901), at 27–8].” Finally, there is a strong possibility that if the only interest of X in Y is an insurance policy there may be a temptation on the part of X to expedite Y’s demise. The preamble to Marine Insurance Act 1746 expressly recognised the danger in these words: “…it hath been found by experience, that the making of insurances, interest or no interest, or without further proof of interest than the policy, hath been productive of many pernicious practices, whereby great numbers of ships, with their cargoes, have…been fraudulently lost or destroyed…” It has been argued [see Harnett and Thornton, chapter 6, [615]] that the effect of requiring interest is irrelevant to the incidence of destruction or murder for if X takes out insurance on Y and Y soon afterwards meets an untimely end, the evidential presumption against X becomes overwhelming… (2) The position at common law The legality of wagers at common law did not arise for decision until the second quarter of the eighteenth century. Up to this period, the courts were laying down general contractual principles and it seems never to have occurred that wagers were anything other than ordinary contracts. As Professor Simpson has pointed out, important concepts have their origins in decisions on wagers. Perhaps the most common and important type of non-gaming wager, at least until 1746 (the year of the first Marine Insurance Act), was that disguised as marine insurance. Such wagers were readily enforceable and although the courts did adopt the “unsettling tendency to impute more serious motives to the

parties than they intended” by construing such policies as requiring proof of loss, policies which were expressed as mere wagers (normally, by the statement that the holder of the policy was deemed to have interest, commonly known as PPI insurances) were undoubtedly lawful. The Marine Insurance Act 1746 (subsequently replaced by the Marine Insurance Act 1906) passed, as we have seen, as a reaction to the fraudulent destruction of insured property and rendered null and void all marine policies by way of gaming or wagering. Given this lead, the courts began a century of seeking ways to avoid their own basic rule as to the legality of wagers, a task in which they were more successful, and the exceptions they developed more numerous, that is commonly supposed. As it is hoped to demonstrate it is highly likely that the courts would have held life policies without interest to be illegal at common law. In addition to the early nineteenth century rule that mere frivolous wagers were unenforceable as being degrading to the courts, there were four grounds on which wagers were regarded as fully illegal. (a) Public Matters. It was argued in Foster v Thackeray (1781) 1 TR 57 that a wager on matter of public importance was per se unlawful, and although there is no record of any judgment ever having been delivered in that case, the dichotomy between public and private affairs was expressly adopted by Lord Mansfield in Murray v Kelly (M.25. G.3) and Buller J in Atherfold v Beard (1788) 2 TR 610. Such dicta ran counter to actual decisions, notably that in Andrews v Herne (1662) 1 Lev 33, in which the validity of a wager on the possibility of Charles II being restored to the throne was not doubted, although the decision did not turn on the point. The full potential of the principle was in fact never properly investigated for most of the cases falling within it were decided on other grounds, principally the evidence rule

(see, in particular, Shirley v Sankey ((1800) 2 B & P 130)) and, at a later stage, public policy. (b) Cases in the seventeenth (Allen v Rescous ((1676)) and early eighteenth (Walkhouse v Derwent (1747)) centuries established that wagers leading to physical violence, bribery and other results contrary to morality would not be enforced. In the landmark decision of Lord Mansfield, in Jones v Randall ((1774) 1 Cowp 37)), it was settled that wagers were subject to the same limitations applicable to other contracts, in particular, that a wager against sound public policy was illegal. Of the cases applying this principle, the most important, for our purposes, is Gilbert v Sykes [see above, [702]]…This wager was held to be unlawful for the reason that each party might be tempted to take steps to ensure that events turned out to his own advantage. Although the case is exceptional in that the court was primarily concerned with the effect of Napoleon’s life or death on England, it is express recognition of the danger faced by those whose death is of interest to others, and arguably supports the proposition that gambling on the lives of public personalities was banned by the common law. (c) Wagers affecting third parties. In the notorious case of March v Pigot ((1771) Burr 2802)), two young men wagered as to which of their fathers would live the longer. Unknown to the parties (one of whom was actually a mere assignee) one of the fathers in question had died before the time of the bet. A claim of total failure of consideration was dismissed and the wager upheld by a court headed by Lord Mansfield, but it must again be noted that although the question of enforceability was peripherally discussed the court was willing — albeit reluctantly — to assume the correctness of the jury’s finding that the intention of the original parties was not to wager but to protect their own future interests. Later courts, treating the case as one of

wagering simpliciiter, regularly expressed their surprise at the result reached but could do no more than lay down the necessarily limited proposition that a wager affecting a third party was illegal only if it were a threat to public peace. However, there are signs that at turn of the nineteenth century the courts were more willing to bypass March and to hold that when a third party was in any way affected a wager was void and illegal. Uninhibited by March, it seems fairly certain that the courts would have reached this result far sooner (Buller J in Good v Elliott ((1790 3 TR 693)). (d) Improper evidence. Using the authority of Coxe v Phillips ((1763) Ca Temp Hard 237)), the courts developed the independent procedural rule whereby if it was apparent that improper evidence was to be introduced the plaintiff would be nonsuited, or if the impropriety appeared at a later stage in the proceedings the trial would be stopped. In some cases, the principle was taken further and nonsuits were granted where such evidence could potentially be introduced even though, in the circumstances, there was no factual possibility of its introduction, as in Atherfold v Beard ((1788) 2 TR 610)), where a bet on the amount of hop duty collected could not be enforced due to the confidentiality of the subject matter even though there was no question of its discussion, the loser of the bet having conceded. In other cases, actual introduction was insisted upon. Whatever the extent of the rule, its importance to us is its effect on wagers affecting third parties, notably, its use as an alternative ground for avoiding the wager in Da Costa v Jones ((1778) 2 Cowp 729)). It is evident that life assurances are likely to produce evidence equally damaging to the life in question. Given the width of these exceptions, it is arguable that the common law would not have tolerated insurances without interest. It is, therefore, to be expected that the courts

would have made optimum use of the 1774 Act to stamp out this particular form of wagering. Despite a promising start that expectation has not been fulfilled. Before the reasons are examined, it is necessary to examine the wording to the Act itself… An intial reading of this statute reveals a determination to rid the common law of its early tolerance of wagers disguised as insurance and, as has been pointed out, there appears to have been no reason to suppose that it would fail. However, 200 years of hindsight has revealed…critical deficiencies either in drafting or omission… II — The Definition of Insurable Interest It is clearly essential to produce a proper definition of insurable interest in order to distinguish idle speculation from genuine loss. Although the Act bars insurance without it (s1) prevents recovery beyond it (s3) no definition is actually provided and it has been left to the courts to fill the gap. The guiding principle is that of pecuniary interest — the insured must be able to demonstrate financial loss on the death of the person on whose life the policy has been taken out. The only exceptions, where proof of financial loss is not an essential prerequisite, are that a man may insure his own life, a wife may insure her husband and a husband his wife… III — The Timing of Insurable Interest (1) Godsall v Boldero (1807) 9 East 72 The policy underlying a decision of exactly when insurable interest should be required to exist reflects a view of the nature of life insurance. If such insurance is to be regarded as providing an indemnity, interest must be fixed at time of death, for loss by death is the insured risk. If so, on the other hand, the investment element is to be regarded as paramount the need for the ultimate beneficiary to suffer and show loss diminishes. As with the nature of interest, the

1774 Act is silent on this vital issue and the matter has been one for resolution by litigation. The question first arose squarely in Godsall v Boldero in which a creditor, being owed over £1,000, insured the life of his debtor for £500. The debtor died insolvent but nevertheless the debt was satisfied by his executors from funds granted by Parliament for this purpose. The creditor then brought an action on the policy. Lord Ellenborough CJ denying recovery refused to regard life assurance as sui generis and applied the normal indemnity principle applicable to other insurances as laid down by Lord Mansfield in the context of a marine policy: “It is a contradiction in terms, to bring an action for an indemnity, where, after the whole event, no damage has been sustained” (Hamilton v Mendes 2 Burr 1210). On principle, the decision cannot be doubted — the policy was a mere security by way of guarantee, and, to have allowed recovery, would have been to assert that a security is enforceable even though the debt has been paid off. Godsall v Boldero was followed in Henson v Blackwell ((1845) 4 Hare 434), in which Wigram VC, using the language of guarantee, held that payment on a life policy after loss of interest was wrongful and thus could not be relied on by the debtor of the insured in reduction of the debt. (2) Dalby v India & London Life Assurance Co (1854) 15 CB 365 Despite these decisions, nineteenth century insurers continued to pay on life policies where interest had lapsed by the time of death. Thus, in Barber v Morris ((1831) 1 M & Rob 62), the court admitted evidence from an insurer that as a general principle payment would in practice be made interest or no interest. Finally, in the Dalby case, as a result of the “chorus of disapprobation” following the decision in Godsall, the law was altered to coincide with commercial understanding — it was conclusively laid down that

insurable interest need only exist at the time of the contract. It is more than a little curious to note that the very decision which established this crucial precedent involved not a life policy but a true indemnity…Parke B allowed Anchor’s claim on the policy holding that, for two reasons, Godsall was incorrect in equating life with indemnity insurance. In the first place, it was pointed out that the premium on a life policy is fixed at the time of the contract only, thereby measuring the interest of the holder at that point. It would therefore be “contrary to justice, and fair dealing, and common honesty” (per Parke B, at p 391) if the happening of an event causing loss of interest deprived the policyholder of the sum purchased by his premium. Further, closely connected with the first point, it was decided that life policies are different in nature from other insurances — the latter seek to compensate for specific loss whereas the former are simply agreements under which a specific sum is to be paid to the insured on death of the life in question. Although these arguments are superficially attractive, it is submitted that both are subject to fundamental objections.

i. Loss of the premium Once it is accepted that the object of the 1774 Act was to suppress wagers on lives, it seems strange that a court should be willing to place the interests of a company taking a calculated gamble on the life of the Duke above those of statutory public policy. This admits, however, that there can be a loss — on careful scrutiny of the fact of Dalby (or, for that matter, of any other case in which interest has lapsed), it is hard to see the injustice complained of. There was clearly no loss of the past premiums: Anchor had bargained for an indemnity on the Duke’s death and, had Wright not surrendered his policies, would have obtained no more than that. A legal requirement lapsing the reinsurance on loss of interest would have left Anchor no worse off — admittedly

no indemnity would have been recovered but there would have been no need for one. Nor can it be argued that the defendants would have been unjustly enriched by the Godsall rule, for they had provided adequate consideration by being on risk until loss of interest. In short, Anchor had received full value for its past premiums. Similarly, there was no future loss: all that Anchor would have been deprived of by a lapsing of its policy would have been the chance to gamble, the chance to assess whether the reward on death would be outweighed by the cost of premiums payable in the meantime. This is precisely what the 1774 Act was intended to prevent, yet is precisely what is granted by Dalby. It therefore seems clear that the only possible loss of which the law should take account on cesser of interest is represented by the unexpired portion of the last premium. Although the common law did not permit the severance of premiums (Tyrer v Fletcher (1777) 2 Cowp 666), it would have been far less damaging to create an exception to that rule than to authorise widespread wagering. In any event, the modern practice of assigning surrender values to life policies ensures that sum of money is available on surrender and in the vast majority of cases this would well exceed any premium loss. To summarise then, no hardship is caused by abrogating the rule in Dalby — indeed there will normally be a gain of the amount by which the surrender value exceeds the unexpired portion of the last premium. Further, as will be demonstrated, in most cases of lapse of interest there is a sensible alternative to allowing wagering.

ii. Promise to Pay on Death, not Indemnity This was the key issue in Dalby. The justification for regarding life policies as non-indemnity is not apparent from Dalby but appears to be based on the notion that loss caused by death is incapable of measurement and thus can never be fully made good. This principle has led to two legal differences between life and other insurances which are of

undoubted wisdom. First, own life insurance may be for an unlimited amount so that a man may provide for his family to the best of his financial ability. Secondly, subrogation has been disallowed. Subrogation operates on the basis that, where a man has bargained for an indemnity, he should receive no more than that, so that, on payment of the policy moneys the insurer becomes entitled to the benefit of rights accruing to the insured in respect of his loss., see, generally, Castellain v Preston (1883) 11 QBD 380. By holding that an indemnity can never be granted, the courts have allowed the insured or his estate to retain the benefit of such rights. It is, however, open to serious doubt whether the decision in Dalby can be justified by the use of this principle. There are two fundamental objections: (1) It is illogical to hold that, because loss is not always quantifiable in cases of death, there is no need to prove any loss at all. It is not the absence of loss that allows unlimited recovery under own-life policies and takes life and accident policies out of the grip of subrogation — in the former case the loss is self-evident, in the latter proof of loss is absolutely vital to the claim — but the impossibility of quantification; (2) It is now generally accepted that certain life policies do, in fact, provide indemnities in the full sense. Reinsurance and creditor-debtor policies are in effect indistinguishable from property insurance in that they seek to provide protection against a fixed loss, and there seems to be no good reason for not requiring that loss has to be shown. This possibility has been discounted by the compounding of two fallacies: firstly by the principle that no loss need be proved on death, and secondly by its application to true indemnities which fall under the general description of “life” policies. What, then, of the non-indemnity forms of life insurance, the family and key-man policies? It has been suggested by Kimball and Davis that such policies, while not whole

indemnities, may be equated to valued policies on property — the sum recoverable is the sum agreed by the parties, and that should be regarded as an indemnity equivalent. Provided, therefore, that some interest (albeit incapable of measurement) does exist on death the policy moneys are treated as “liquidated damages.” Taking a wider perspective, it is strongly arguable that all life insurance is in real terms indemnity in nature (Kimball and Davis at 855): “intangible…personal insurance is rarely designed to compensate for the loss of…things; rather it is designed to compensate for the accompanying economic loss. In this respect it indemnifies…just as much as do fire and marine insurance. If there is a difference, it is only one of degree. No one would deny the indemnity character of a policy…on an animal or painting. But the loss of a beloved animal or favourite painting may far transcend the economic loss. Yet it is the latter against which the insurance is taken out, and which makes it indemnity insurance. Moreover, even in personal insurance, there is an underlying assumption that…it indemnifies for economic loss actually suffered even if there is not a precise quantitative equivalence between loss and reimbursement.” It is not necessary to adopt this view in its entirety to accept that the bland statement that a life policy can never be an indemnity is far too simplistic and superficial an analysis of the position. (3) The Legal Consequences of Dalby The above has been an attempt to show that the supposed non-indemnity role of life assurance is inadequate justification to support the rule in Dalby, for not requiring interest on death. Indeed, the law up to Dalby, inclined in favour of the indemnity construction and the subsequent

superimposition of the Dalby rule has inevitably caused inconsistency and problems in application. The major inconsistency is with the definition of insurable interest itself. As already demonstrated, the law adheres to a strict financial evaluation based on principles of indemnity. It is thus strange to find that such calculations are relevant only at the date of the policy and have no bearing on the actual amount recoverable. If further proof of inconsistency is required it is to be found in section 3 of the 1774 Act which, it will be remembered, confines recovery to the amount of the interest. Dalby limited section 3 to the insurable interest as valued at the time of the contract. The effect is that only in cases where the interest has remained constant throughout the currency of the policy does section 3 attain its intended purpose. If the interest lapses after the policy is issued, the result is the possibility of speculation; if it diminishes — as in debtor-creditor cases — the result is potential profit. Conversely, if the interest increases in that period it cannot be insured against. Thus, where an employer insures the life of a key employee lie is confined to the value of the employee’s services at the date of the policy, disregarding the likely increase in his worth. Such difficulties would have been averted by a contrary decision in Dalby. (4) The operation of Dalby Perhaps the most damning criticism of Dalby is that the decision frustrates the primary object of the 1774 Act by authorising forms of gambling at least as repugnant as the initial procuring of a policy without interest. Such gambling can occur in four common situations.

i. Husband and Wife In Connecticut Mutual Life Insurance Co v Schaeffer 94 US 457 (1877), a husband and wife took out a joint life policy, the proceeds being payable to the survivor. They were later

divorced (both in fact remarried) but the policy was maintained by the ex-wife and on the death of her exhusband she brought an action on it. The Supreme Court, holding that the combined effect of the 1774 Act and Dalby represented US common law, allowed the action. Bradley J, giving judgment on behalf of the whole court, rested his decision on two grounds: that the law is concerned only to prevent gambling at the inception of the policy, and that it is unfair to deny recovery after a valid policy has existed for a considerable period (the same argument presented in Dalbys case). “…it would be very difficult, after the policy had continued for any considerable time, for the courts, without the aid of legislation, to attempt an adjustment of equities arising from a cessation of interest in the insured life. A right to receive the equitable value of the policy would probably come as near to a proper adjustment as any that could be devised. But if the parties themselves do not provide for the contingency, the courts cannot do it for them.” The court here strongly implies that allowing recovery was a lesser evil than denying it. If there were no other alternative, the lesser evil would have been justified, but there are in fact two further possibilities. First, it is desirable on the break up of marriage for the parties to settle their affairs as justly as possible and there is no reason for insurance to be excluded from any agreement. A policy by one spouse on the other can easily be converted into an own-life policy, as can a policy of the Schaeffer type. If, however, agreement is impossible, the second alternative — the surrender for an “equitable value”, recognised by Bradley J — comes into play. Surrender values are today universal in life policies but are often subjected to the charge of being too low, especially in the early stages of the policy. Here it is pertinent to go no further than to point out

that England is one of the few countries not to regulate surrender values. The important matter is that Schaeffer is a decision resting on plainly dubious assumptions not following the decision does not result in unfairness, it merely eliminates the opportunity of the surviving spouse to gamble, or to sell the policy and thereby allow a total stranger to gamble.

ii. Employer and Employee A similar problem arises when an employer maintains a keyman policy on the life of an employee. On principle, Dalby authorises this, and it has been held by the Michigan Court of Appeals that an employer is entitled to retain the proceeds of such a policy for his own benefit. Again it seems unnecessary to authorise gambling when there are better alternatives. The fairest solution is allow the employee to purchase the policy from the employer at an agreed price so that it becomes an own-life policy [see 65 Yale LJ 736 (19560], but in the absence of the employee’s willingness to buy, the surrender value should be the employer’s only right of recovery. iii. Creditor and debtor Dalby itself illustrates that a creditor is entitled to insure for the amount of the debt owing when the policy is taken out, so that when the debt is fully paid the policy can be kept up by the creditor. Conversely, it appears that if on the debtor’s death the debt is unpaid, payment on the policy by the insurer does not discharge the debt. As a result, when the debt is paid the policy becomes nothing more than an opportunity to wager but when the debt is unpaid the chances of double indemnity rest only on the solvency of the debtor’s estate. These consequences are defended by MacGillivray (para 1745) on the grounds of privity of contract: in the former case the insurer has contracted to pay a fixed sum and thus cannot complain if he is forced to

pay it even though the creditor has been fully reimbursed under his contract with the debtor; in the latter case there is no reason for the debtor to benefit from a personal contract made by the creditor with the insurer. It is submitted that, once the guarantee nature of this type of insurance is recognised, these results are unsupportable. Payment by the debtor ought to discharge the contract of insurance subject to the surrender value, whilst payment by the insurer ought to discharge the debtor (with no possibility of subrogation). Adopting this approach, taken by the common law in Henson v Blackwell (1845) 4 Hare 434, before Dalby, would have the additional benefit of allowing the creditor to insure for future interest and premiums. Alternatively, such policies should be banned, and wholly replaced by policies which are in essence own-life by the debtor but render the creditor beneficiary until repayment of the debt. The choice of continuing or lapsing the policy rests with the debtor and not the creditor, thereby eliminating the wager.

iv. Assignment to a person without interest The present law authorises a subsequent assignment of either the policy itself or of the right to recover its proceeds on death to a third party, whether or not that person has an insurable interest. There is, however, one important limitation: “…there is nothing to prevent any person from insuring his own life a hundred times…provided it is bona fide an insurance on his own life, and at the time, for his benefit, and that there is nothing to prevent him from dealing with such policies by assigning them to someone else…even though at the time lie effected the policies he had the intention of so dealing with them…But if, ab initio, the policy effected in the name of A is really and substantially intended for the benefit of B and B only,…that is within the evil and mischief of [the 1774 Act] [per Pollock B,

M’Farlanev. The Royal London Friendly Society (1886) 2 TLR 755, 756].” The law thus seems to be that general intent to assign on taking out the policy is outside the Act but an intent to assign to a specified person is within it, where no interest exists. Although this may be an easy proposition to state it is not so easy to apply to practical situations. Admittedly, the facts may be clear cut, where the use of an own-life policy to hide an insurance without interest is the obvious intent, but other cases involving purely innocent transactions require very fine distinctions to be drawn, of necessity without the evidence of the leading witness. Although such assignments are a regular feature of commercial life, it must seriously be questioned whether they are justifiable on principle… (5) Practical Justifications of Dalby The true reason for the vociferous objects of the insurance world to Godsall v Boldero and of insurers’ subsequent adherence to Dalby is best explained by Holmes J in Grigsby v Russell ((222 US 149 (1911)): “life insurance has become in our days one of the best recognised forms of investments and self-compelled saving. So far as reasonable safety permits, it is desirable to give life policies the ordinary characteristics of property…To deny the right to sell except to persons having an interest is to diminish the value of the contract in the owner’s hands…” (6) Conclusions …it is submitted that the law should require proof of interest at date of death, the amount recoverable being limited to actual loss. If interest lapses the policy should automatically lapse with it, subject to payment of the appropriate

surrender value (on the assumption that the policy is whole life and not term)… Suggestions for reform …the circumstances in which the insured will be able to recover his premium are very limited. A major criticism which can be levelled at the present effect of lack of interest is the total disinterest of the law in the relative fault of the parties. There can be no sympathy for a fraudulent assured who misrepresents his interest, but should the result be the same where the illegality is largely attributable to the insurer? This question may arise at two stages during the formation of the contract. (a) most of the cases have involved insurance sold by unskilled commission agents, and, in some, the policies have been positively canvassed by the agents. While it seems that over enthusiasm rather than fraud has been the cause of the majority of misrepresentations it is difficult to see why the insured rather than the insurer should bear the burden of the agent’s inadequate lack of training. Unskilled agents are rarer today but if an insurer considers them to be an economic advantage it is outrageous that he should be allowed to retain the premiums obtained by their deficiencies; (b) an insurer is under no legal obligation to check the validity of the policies that he issues — on the contrary if he fails to do so he will receive the benefit of the premiums. Although the point has not been seriously argued in England it has been held in the United States that issuing a policy without interest in the absence of reasonable investigation is actionable negligence ((Liberty National Life Insurance Co v Weldon 267 Ala 171 (1957)). Perhaps the most important consideration in the quest for reform is to determine whether premium confiscation is an appropriate sanction, for it can do little to prevent the

formation of illegal insurances. It is submitted that, in order to stop the problem at source, it is necessary to place on the insurer the major burden of ensuring that policies without interest are not issued. In order to assist in this task, it has already been suggested that a code of insurable interests should be drawn up, and it is further suggested that an insurer should incur a fine for issuing a policy in breach of that code unless he can show that he could not reasonably have discovered the lack of interest, as when the insured is himself fraudulent. It remains to determine the fate of the premiums when no interest exists. When the insured is fraudulent and the insurer has no reasonable method of discovering the fraud, the common law produces a satisfactory result. When, however, the fraud could have been discovered, justice denies either party the benefit of the premiums. In such a case, it seems fairest to offer the opportunity to take up the policy to the life insured thereunder or, if the contingency has occurred, to pay the sum insured to his estate, unless, of course, he is a party to the fraud. It may be argued that this gives a windfall to the life assured under the policy but as against that must be weighed the importance of stamping out wagering insurances and also the fact that, while such insurance exists, his life is in potential danger. Finally, where the insured has taken out a policy without interest in good faith, the simplest and fairest solution is to allow recovery of the premiums and their proceeds.’

Notes: The interrelation between sections 1 and 3 of the LAA 1774 and the question of the date at which insurable interest must be demonstrated and valued was

recently considered by both the trial judge and the Court of Appeal in Feasey: [707] Feasey (representing Syndicate 957 at Lloyd’s) v Sun Life Assurance Co of Canada [2002] EWHC 868 (Comm) [The facts appear from the judgment of Waller LJ in the Court of Appeal, see below, [708]]. Langley J: ‘Despite the wording of the preamble it is not at all clear from the reference works to which my attention has been drawn what was the nature of the mischievous kind of gaming at which the Act was aimed nor why it needed to do so; nor, in, indeed, is it clear to me what purpose the Act serves today insofar at least as it extends beyond gaming which, as a matter of language, Section 1 purports to do by the use of the words no interest or by way of gaming or wagering. At common law wagering contracts were not illegal; nor were contracts expressly agreed to be interest or not interest. Indeed that language may explain the use of the words no interest in the Act. The Marine Insurance Act 1746 prohibited wagering policies on risks connected with British shipping. The preamble to that Act shows that the major purpose was prevention of the fraudulent loss or destruction of ships and their cargoes. Parks treatise on A System on the Law of Marine Insurances 7th edn 1812, suggests that the target was to outlaw the insuring of ideal risks (used in contrast to an indemnity against loss from real risks) meaning risks with no reference whatever to actual trade or commerce. The target of the 1774 Act, according to Park, was the insurance of lives with which the assured had no connection as a mode of gambling possibly because it was

undermining the security of insurance companies. No doubt, as [counsel for the insurers] submitted, in the early nineteenth century the law of disclosure had not been developed to provide the protection to insurers which it does today. What, however, I think is undoubted is that the purpose of the legislation was indeed to prevent gaming in the disguise of insurance and in the sense of gambling on the outcome of an uncertain event in which the assured had no interest save for the interest created by the very gamble or agreement itself…In that context a purpose can also be divined for section 3. Section 1 outlaws insurance in which there is no interest at all. Section 3 bites where there is an interest but prevents recovery of more than the value of the interest. Otherwise it would be possible to insure a genuine interest in an amount many times the value of any loss which could possibly be occasioned which would in principle be no different from gaming on the excess… In my judgment there is no requirement to be found in Section 3 to enter into any detailed examination of the values of insurable interests with or without the benefit of any hindsight. Nor is it required that a court should examine and assess whether a given value was arrived at without negligence or reasonably. The underlying purpose of Section 3 is derived from Section 1: to outlaw recovery of the proceeds of what is properly to be described as gaming or wagering….’

[708] Feasey v Sun Life Assurance Co of Canada [2003] EWCA Civ 885 [The facts appear from the judgment]. Waller LJ: ‘How does the Insurable Interest point arise?

Steamship insured the liabilities of their members for personal injury or death. In about June 1995, rather than entering into a conventional reinsurance with Syndicate 957, Steamship and Syndicate 957 entered into a Personal Accident and Illness Master Lineslip Policy. The aim was to cover the liability of Steamship to its members. Under the Master Lineslip the syndicate agreed to pay fixed benefits to Steamship in respect of bodily injury and/or illness sustained by a person (an original person) who was engaged in any capacity on board a vessel or offshore rig, entered by a member with Steamship. That Master Lineslip was renewed from time to time. In particular, in about May 1998, it was renewed in respect of losses occurring on declarations attaching during three consecutive periods of 12 months from 20 February 1997 and, later, in respect of losses occurring on declarations attaching during the period 20 February 2000 to 20 February 2001. Syndicate 957 reinsured its liability under the Master Lineslip. That reinsurance for the years February 1998 to February 2000, was 50per cent with Sun Life and 50 per cent with Phoenix. That reinsurance was negotiated by brokers acting for Syndicate 957 and Centaur who were authorised at this stage to write for those two companies in the above proportions. On 1 October 1998 Centaur’s authority to write new business for Phoenix ceased. The brokers negotiated an extension of reinsurance with Centaur for a further year on 29 October 1998. It is that negotiation which gives rise to the authority point and the question whether Centaur was agreeing to take 100 per cent for Sun Life. It is Sun Life who have taken the point that Steamship had no “insurable interest” in the lives and well-being of the original persons, when entering into the Master Lineslip for the three years from February 1997 and after. They contend that the insurance is illegal by virtue of section 1 of the Life Assurance Act 1774. In the alternative Sun Life and Phoenix

assert that Steamship are seeking to claim more than the value of any insurable interests they had, and are not entitled to do so by virtue of section 3 of the same Act. It is not attractive to contemplate that where insurers have carefully crafted a policy which was intended to be enforceable by Steamship, a point on insurable interest could arise… Date for insurable interest and valuation One other general point to make at this stage relates to the date at which an insurable interest must exist, and (where relevant) the date at which it must be valued. In an indemnity policy the relevant date is the date of loss. If the policy is not a valued policy, liability will also be assessed at the date of loss. Where the policy is a valued policy, that value will have been assessed at the date of the policy, and in the absence of fraud the value fixed by the policy will as between the insurer and the assured be conclusive of the insurable value of the subject intended to be insured whether the loss be total or partial (see section 27(3) of the Marine Insurance Act 1906). In a life policy the date at which the insurable interest must exist is the date of the taking out of the policy. Furthermore, that is the date for valuing the insurable interest (see Dalby)…’

7.3 Determining Insurable Interest ‘Insurable interest’ is not defined by the 1774 Act although some indication of its nature is evident from the language of section 3 which speaks of a financial or pecuniary interest in the life insured (see above). The difficulties of formulating a precise definition, whether for the purposes of life insurance on the one

hand, or indemnity insurance on the other, were noted by Waller LJ in Feasey (above, [708]): ‘it is difficult to define insurable interest in words which will apply in all situations. The context and the terms of a policy with which the court is concerned will be all important. The words used to define insurable interest in for example a property context, should not be slavishly followed in different contexts, and words used in a life insurance context where one identified life is the subject of the insurance may not be totally apposite where the subject is many lives and many events… When one examines the authorities therefore one sees that the court is concerned to analyse by reference to the terms of the policy what is the subject of the insurance; to analyse what insurable interest a person has in the subject of the policy; and to consider whether the subject “embraces that insurable interest” in the words of Blackburn J in Anderson v Morice (1875) 10 CP 609 at 622. Where on the wording of the policy the subject is not absolutely clear cut, it sometimes assists to identify the subject to ask what insurable interest the person has, but essentially the subject is defined by the words of the policy. It follows that in some cases the subject is so clear, that even when the insured can identify some insurable interest that it might have had, it will be held that the insured has failed to cover that interest by the policy. In other cases what is “embraced” within the subject of the policy is less clear-cut, and in those circumstances the court may be able to say that the insurable interest is embraced within the subject of the insurance. The different elements of subject, insurable interest, and value are separate but impact one on the other…’

By way of summary, Waller LJ concluded:

‘In a policy on life or lives the court should be searching for the same broad concept. It may be that on an insurance of a specific identified life, it will be difficult to establish a “legal or equitable” relation without a pecuniary liability recognised by law arising on the death of that particular person. There is however no authority which deals with a policy on many lives and over a substantial period and where it can be seen that a pecuniary liability will arise by reference to those lives and the intention is to cover that legal liability…The interest in policies falling within section 1 of the 1774 Act must exist at the time of entry into the policy, and be capable of pecuniary evaluation at that time.’

The difficulties of finding interest is made simple in three classes of life policies because insurable interest is readily identifiable: i. interest that is predicated on marriage — it is presumed that a husband or wife has an economic interest in the survival of the insured spouse. ii. relationships based purely upon pecuniary interest — for example, between employers and employees (see Hebdon v West, below, [713]) or secured creditors and their debtors (see Godsall v Boldero, below, [714]). iii. where the insured effects a policy on his or her own life — insurable interest is also presumed and, notwithstanding the indemnity principle, such interest is unlimited (see Wainwright v Bland, below, [721]). This is readily understandable given the practical difficulties of putting an economic value on a life (unlike property).

The Insurance Ombudsman has held that the presumption of interest should extend to engaged couples (Annual Report, 1989, paras 2.31–2.35).

7.3.1 i. Spouses [709] Griffiths v Fleming [1909] 1 KB 805 (CA) [A husband and wife effected a joint policy whereby £500.00 would be payable to the survivor upon the death of either spouse. The wife committed suicide and the husband claimed under the policy. The insurers argued that the husband lacked insurable interest in the life of his wife as required by the Life Assurance Act 1774]. Kennedy LJ (reading the judgment written by Farwell LJ): ‘It is to be observed that the words of section1 are assurance “by any person on the life of any person,” not “on the life of any other person,” and section 2 applies to an insurance effected by a man on his own life…I find it difficult, however, to see what pecuniary interest, in the sense of pecuniary loss arising from the loss of some legal interest, a man can be said to lose on his own death, and it has been held in Wainwright v Bland [see below, [721]] that every man is presumed to have an interest in his own life and in every part of it, and that an executor suing on a policy effected by his testator on two years of his life is not bound to shew that such testator had any special reason for making such limited assurance. But this must be on the ground that an insurance by a man on his own life is not within the mischief of the Act. A man does not gamble on his own life to gain a Pyrrhic victory by his own death. I cannot persuade myself that such an insurance is of a pecuniary interest…The loss is in both cases his own, being either of his life or of his premiums; the pecuniary gain is his executor’s. In Reed v Royal Exchange Assurance Co Peake,

Add Cas 70, Lord Kenyon went a step further and held that a wife as such has an insurable interest in her husband’s life, and he refused to allow evidence to be given by her that her late husband was entitled to a life interest of large amount. This shews that he regarded the husband and wife in the same position as the individual insured, for he would otherwise have been bound to take the evidence in order to satisfy section 3 of the Act. If the wife’s insurable interest depended on her right to necessaries at her husband’s expense or on the possession by the husband of a life interest, the judge could not of his own motion have excluded all evidence to shew the age of the spouses at the date of the insurance and the value of the interest or necessaries according to the station in life of the parties as compared with the sum assured. The case is very shortly reported, but in my opinion Lord Kenyon excluded the evidence on the same grounds on which evidence of insurable interest in the insurer for his own benefit would be excluded, namely, that the case was not within the mischief of the Act. If this be so, it follows, in my opinion, that the same principle must be applied to the insurance by the husband of the wife’s life; a husband is no more likely to indulge in “mischievous gaming” on his wife’s life than a wife on her husband’s. It is not a question of property at all; it is that for this purpose husband and wife stand on the same footing and that the ruling of Lord Kenyon a century ago in favour of the wife’s claim ought now to be applied in favour of the husbands.’

Note: The law is strict in limiting the presumption of insurable interest to spouses and own-life policies. In such insurances the judges have expressed the view that concerns over wagering simply do not arise (see

Griffiths v Fleming, above, [709]). However, in order to effect a valid life policy on a family member the insured must satisfy section 3 of the 1774 Act. Further, it has been held that notwithstanding the language of section 1 of the 1774 Act (which declares policies without interest “null and void”, above, [704]), the absence of insurable interest renders the policy illegal Harse v Pearl Life Assurance Co (below, [710]; see, however, the disquiet expressed over the illegality point by Ward LJ, dissenting, in Feasey (above, [708]). No interest in family members [710] Harse v Pearl Life Assurance Co [1904] 1 KB 558 (CA) [The insured took out two policies on the life of his mother. She lived with him as his housekeeper and he paid her an allowance. The insured’s father was paralysed and, being incapable of work, he would be unable to pay the mother’s funeral expenses in the event of her predeceasing him. When the insured discovered that the policies were void for want of insurable interest, there being no obligation on a child to bury a parent [reported at [1903] 2 KB 92], he sought to recover the premiums paid by him on the basis that there had been a total failure of consideration (in fact, the premiums he had paid exceeded the sum insured)]. Collins MR:

‘This is an appeal from a decision of a Divisional Court…[I]f the plaintiff had been under any liability to pay the funeral expenses of his mother, the policy would be valid, and the premiums could not be recovered back. On the assumption that the policy was illegal, the plaintiff has paid money to the defendants upon an illegal bargain, and the question is whether he can recover it back…The jury have found as to both policies…that they were taken out in consequence of the [innocent] representation of an agent of the defendants that they were good policies…It is clear law that where one of two parties to an illegal contract pays money to the other in pursuance of the contract, it cannot be recovered back. That rule was applied to a case similar to the second of these policies in Howard v Refuge Friendly Society ((54 LT 644)). We therefore begin the discussion with the rule of law that prima facie the plaintiff would be debarred from recovering the premiums paid on either policy. In this state of things it is said that what occurred between the plaintiff and the company’s agent relieves the plaintiff from the operation of the rule. The statement, however, made by the agent was not a statement of fact, but one of the law, and was made innocently, as the jury have found. Unless there can be introduced the element of fraud, duress, or oppression, or difference in the position of the parties which created a fiduciary relationship to the plaintiff so as to make it inequitable for the defendants to insist on the bargain that they had made with the plaintiff, he is in the position of a person who had made an illegal contract and has sustained a loss in consequence of a misstatement of law, and must submit to that loss. Neither on the findings of the jury, nor in the evidence, can I find anything that brings the case within any of the classes that I have indicated. Under those circumstances, the plaintiff cannot recover back the premiums that he has paid.’

[711] Worthington v Curtis (1875) 1 Ch D 419 (CA) [The facts appear from the judgment]. Mellish LJ ‘[T]he question is, whether a policy of assurance which was effected by the father on the life of his son, and in his son’s name, was the son’s policy or the policy of the father, who is his administrator, and claims it, not as administrator, but on the ground that he is the person, as between himself and his son, who is entitled to the money. In the first place, we must consider the question of fact, whether the Defendant has given sufficient evidence that as between himself and his son it was really intended that the policy should be for the benefit of the Defendant…On that point we have the Defendant’s affidavit that he owed £400.00 to his son on account of a legacy which the Defendant had received, and that when he offered to pay it to his son his son demurred to receive it, on account of the expense to which his father had been put in his education… but…as it is sworn by the father that he effected the policy on hos own account, and this is confirmed by the evidence of his wife, and as for a period of nearly ten years he regularly paid the premiums and kept the policy in his own possession, we think there is no sufficient reason for differing from the conclusions arrived at by the ViceChancellor, that as between the father and the son the policy was the property of the father. It was, however, contended on behalf of the Appellants, that, assuming the policy to be the property of the father, it would follow that it was an illegal policy within the statute 14 Geo 3, c 48, because although it was made in the name of the son, the father, who really effected it for his own benefit, had no insurable interest in his son’s life. I agree that even if the story told by the father is true as to the

expense to which he had been put in his son’s education, that gave him no such interest in his son’s life as would support the policy; and I am therefore of opinion that the insurance company would have had a good defence under the Act if an action had been brought against them on the policy. But although the company had sufficient knowledge of the circumstances to call their attention to the question, they acted as insurance companies usually do, and never attempted to set up this defence, and when administration to the son was taken out by the father they paid the money without further dispute to him. The question, then, is, whether the money having been so paid, it is part of the intestate’s assets, or belongs to the father. Now, the creditors are claiming under the son, and they can have no greater right to the money than the son had when alive. They claim through him in the same way as executors or trustees in bankruptcy, and have no greater right than the testator or the bankrupt in ordinary cases. This case, therefore, really depends on the question whether, as between the father and the son, the policy belonged to the one or the other. I think it clearly belonged to the father. One test of this is whether, if the son had brought an action of detinue for the policy against the father, he could have recovered it on the ground that the father had no right to it be reason of the statute of Geo 3? Clearly not. It did not belong to the son but to the father, who had obtained it from the company, and had paid the premiums out of his own money. Again, if the father had wished to surrender it to the company for a valuable consideration, could the son have interfered to prevent him from carrying the surrender into effect? Could he have brought an action for money had and received to recover the amount paid by the company on such a surrender, or could he have maintained a suit in equity to restrain the transaction from being completed? Clearly not. He had

nothing to do with it; both the policy and the value of it belonged to the father. Then the son dies, and the money becomes payable on the policy. Assuming that a creditor, instead of the father, had taken out administration, could he have maintained an action of detinue against the father for the policy? Certainly not. He would have been in the same position as the son before his death, and the son having no property in the policy his administrator would have had no right to it either. Then, supposing the company chooses voluntarily, and without taking advantage of the statute, to pay the money to the father — I say voluntarily, because neither party could have maintained an action against the company — could the administrator of the son have recovered the money from the father? Clearly not. In my opinion, therefore, there are two reasons for which the appeal must fail. First, because the statute is a defence for the insurance company only, if they choose to avail themselves of it. If they do not, the question who is entitled to the money must be determined as if the statute did not exist. The contract is only made void as between the company and the insurer. And, secondly, if that is not so, and if the effect of the statute is that the court will give no relief to any party because of the illegality of the transaction, in that case the maxim, melior est conditio possidentis must prevail, and the party who has the money must keep it…’

[712] Halford v Kymer (1830) 10 B & C 724 [The claimant effected a life policy on the life of his son, Robert, naming himself as beneficiary should Robert die before reaching 21 years. The father’s claim was rejected].

The submission of F Pollock: ‘Now, the plaintiff clearly had an interest in the life of his son, for be might reasonably expect that the latter would reimburse him the expenses of his maintenance and education. This clearly was not a wagering policy within the meaning of [the 1774 Act]. It is true that the third section enacts “That in all cases where the assured hath interest in such life or lives, event or events no greater sum shall be recovered or received from the insurer than the amount or value of the interest, insured on such life or lives, or other event or events.” It is clear that a man may effect an insurance on his own life, although he may have no pecuniary interest depending on it, and although his own income may be of the most ample kind, not depending on his own exertions or on any contingency ; and if that be so, upon what principle can it be said that he cannot have an insurable interest in the life of his son or his wife? If a man be deprived of the comfort, society, and assistance of his wife by the misconduct of another, he may recover damages for that loss. So, if he be deprived of the services of his daughter by her seduction, or if he lose the assistance of any other member of his family by the wrongful act of another, he may maintain an action for damages. Surely the law which gives a man a right of action for the wrongful act of another, by which he is deprived of the assistance of his wife, daughter, or servant, will not prevent him from protecting himself against that casualty which for ever deprives him of that assistance. [Bayley J In Innes v The Equitable Assurance Company (which was tried before Lord Kenyon), the plaintiff had effected a policy on the life of his daughter. In order to shew that he had an interest, he produced a paper, purporting to be a will, by which it appeared that he was entitled to the sum of £1,000 in the event of his daughter dying under the age of 21. One Gardiner swore that he was a subscribing witness to the will, and that it was made at Glasgow, and that he was

acquainted with the other subscribing witnesses; but another of those witnesses stated, that it was not made at Glasgow, but by a schoolmaster in the borough. Innes was tried, convicted, and executed for the forgery, and Gardiner, who had sworn that the will was made at Glasgow, was. convicted of perjury.] [Lord Tenterden CJ. It was in effect admitted, in that case, that it was necessary to prove that the father had a pecuniary interest in the life of his daughter, otherwise there would have been no occasion to go into the question as to the will; and unless it were a fact material in the case, the witness could not have been convicted of perjury.] That was only a Nisi Prius case. But a father has a legal interest in the life of his son sufficient to entitle him to insure. By the Statute of Elizabeth, if a father become poor in his old age, and his son be capable of maintaining him, be is bound to do so. Now, why does a man insure the life of his debtor? Because the death of his debtor diminishes the chance of his being paid. So, if a son dies, the chance of the father being maintained in poverty and old age is diminished. [Bayley J. The parish is bound to maintain him, and it is indifferent to him whether he be maintained by the parish or his son.] The amount of maintenance which a parish must afford may, in many cases, be much less than that which a son would be ordered to pay. Besides, a father may have a claim on his son, when he has no claim on the parish. He may not be able to shew his settlement in the parish from which, he claims relief. In that case the life of his son would be of importance to him, as affording him the certainty of having a comfortable provision. The word “interest” in the Act of Parliament is not to be confined in construction to pecuniary interest, but may be taken to mean legal interest; and the third section which allows the insured to recover to the amount or value of. his interest, shews that the law would recognise an interest of any kind, provided a value can be set upon it.’

Lord Tenterden CJ: ‘I retain the opinion which I expressed at the trial, that the word interest in this statute means pecuniary interest.’ Bayley J: ‘It is enacted by the third section, “That no greater sum shall be recovered than the amount of the value of the interest of the insured in the life or lives.” Now, what was the amount or value of the interest of the party insuring in this case? — Not one farthing certainly. It has been said that there are numerous instances in which a father has effected an insurance on the life of his son. If a father, wishing to give his son some property to dispose of, make an insurance on his son’s life in his (the son’s) name, not for his (the father’s) own benefit, but for the benefit of his son, there is no law to prevent his doing so; but that is a transaction quite different from the present; and if a notion prevails that such an insurance as the one in question is valid, the sooner it is corrected the better.’

7.3.2

ii. Policies Effected by Employers/Employees and Secured Creditors/Debtors

[713] Hebdon v West (1863) 3 B & S 579 [The facts appear from the judgment]. Wightman J: ‘There are two questions in this case. The first is whether Hebdon had any insurable interest at all in the life of Pedder; and the second, whether, assuming that he had an insurable interest, the payment of the £5,000 by the [first

insurer], as stated in the second plea, is an answer to the plaintiff’s claim. With respect to the insurable interest of the plaintiff, it was determined, in the case of Halford v Kymer [above, [712] that, unless the insured have a pecuniary interest in the life insured, the policy is void by the 14 G 3, c 48, section 1. In the present case, it was contended for the plaintiff that he had two kinds of insurance interest in the life of Pedder — one, on the ground of a promise that Pedder had made to him that he (Pedder) would not enforce the payment of any debt that the plaintiff might owe him during his (Pedder’s) lifetime, and the other, on the ground that the plaintiff was in the employ of Pedder at a salary of £600 a year, under an agreement that the engagement should last for seven years. We do not think that the first kind of interest in the life of Pedder, namely that he had said that he would not enforce payment of debts due to him from the plaintiff during his (Pedder’s) life, without any consideration or any circumstance to make such a promise in any way binding, can be considered as a pecuniary or indeed an appreciable interest in the life of Pedder. The other kind of interest, namely that which arises from the engagement by Pedder to employ the plaintiff for seven years at a salary of £600 a year, may, we think, be considered as a pecuniary interest in the life of Pedder, to the extent at least of as much of the period of seven years as would remain at the time the policy was effected, which appears to have been about five years. This, at the rate of £600 per annum, would give the plaintiff a pecuniary interest in the life of Pedder to the amount of £3,000 which would be sufficient to sustain the present policy, which is for £2,500 only. We assume, then, that the plaintiff had a pecuniary interest in the life of Pedder to the extent of £2,500 at the time he effected the policy with the defendant’s office. If that be so, the question then arises whether payment, after the death of Pedder, of £5,000 by another life insurance

Company, with whom the plaintiff had also insured Pedder’s life to that amount, is a bar to the plaintiffs claim by virtue of the third section of the 14 Geo 3, c 48, it being taken as a fact that the £5,000 included all the insurable interest that the plaintiff had at the time of making both policies — in fact that the interest of the plaintiff at the time of making the insurance with the defendant was the same as that which he had when he made the insurance with the other Company. …Looking to the declared object of the legislature, we are of opinion that though, upon a life policy, the insurable interest at the time of the making the policy, and not the interest at the time of the death, is to be considered, it was intended by the third section of the Act that the insured should in no case recover or receive from the insurers (whether upon one policy or many) more than the insurable interest which the person making the insurance had at the time he insured the life. If for greater security he thinks fit to insure with many persons and by different contracts of insurance, and to pay the premiums upon each policy, he is at liberty to do so, but he can only recover or receive upon the whole the amount of his insurable interest, and if he has received the whole amount from one insurer he is precluded by the terms of the third section of the statute from recovering or receiving any more from the others. Any argument arising from the supposed hardship of allowing the insurers in such a case to receive and retain the premiums without being obliged to pay the consideration for which such premiums were paid, would be equally applicable to the case of marine insurances, upon which, however many policies there may be, the underwriters are only liable to the extent of the value insured…’ Judgment on the demurrer for the defendant.

[714] Godsall v Boldero (1807) 9 East 72

[A creditor who was owed some £1000 insured the life of the debtor for £500. When the debtor died the debt was discharged by his executors. The creditor sought to claim under the policy]. Lord Ellenborough CJ: ‘This was an action of debt on a policy of insurance on the life of the late Mr Pitt, effected by the plaintiffs, who were creditors of Mr Pitt for the sum of £500.00. The defendants were directors of the Pelican Life Insurance Company, with whom that insurance was effected. [His Lordship, after stating the pleadings and the case, proceeded] — This assurance, as every other to which the law gives effect, (with the exceptions only which are contained in the 2nd and 3rd sections of the stat. 19 Geo 2, c 27, [see chapter 6]), is in its nature a contract of indemnity, as distinguished from a contract by way of gaming or wagering. The interest which the plaintiffs had in the life of Mr Pitt was that of creditors; a description of interest which has been held in several late cases to be an insurable one, and not within the prohibition of the stat. 14 Geo 3, c 48, section 1. That interest depended upon the life of Mr Pitt, in respect of the means, and of the probability, of payment which the continuance of his life afforded to such creditors, and the probability of loss which resulted from his death. The event, against which the indemnity was sought by this assurance, was substantially the expected consequence of his death as affecting the interests of these individuals assured in the loss of their debt. This action is, in point of law, founded upon a supposed damnification of the plaintiffs, occasioned by his death, existing and continuing to exist at the time of the action brought: and being so founded, it follows of course, that if, before the action was brought, the damage, which was at first supposed likely to result to the creditors from the death of Mr Pitt, were wholly obviated and

prevented by the payment of his debt to them, the foundation of any action on their part, on the ground of such insurance, fails. And it is no objection to this answer, that the fund out of which their debt was paid did not, (as was the case in the present instance,) originally belong to the executors, as a part of the assets of the deceased; for though it were derived to them aliundè, the debt of the testator was equally satisfied by them thereout; and the damnification of the creditors, in respect of which their action upon the assurance contract is alone maintainable, was fully obviated before their action was brought…’

Notes: 1. Dalby (above, [705]) shows that insurable interest must exist only at the inception of a life policy cf Godsall. As a consequence, Merkin has argued that the position is now that the creditor-insured may recover the whole sum notwithstanding that the debt has been repaid before the debtor’s death: see R Merkin “Gambling by insurance — a study of the Life Assurance Act 1774” (above, [706]). However, in Feasey (above, [707]), although Langley J at first instance thought that Hebdon was inconsistent with Dalby, Waller LJ explained that: ‘Dalby and Hebdon are consistent on the following basis. The value of an interest at the time of taking out the policy is assessed on the maximum pecuniary loss that the assured could suffer on the death of the life assured. In Dalby that was £3,000; in Hebdon that was £3,000. Nothing in excess of those values could be recovered. In Dalby that

led to recovery of £1,000, and in Hebdon that led to a result that since more than £3,000 had been covered by the first policy, there was no interest in taking out a second policy.’

2. Notwithstanding the remarks in Hebdon v West (above, [713]) to the contrary, a debtor may possess insurable interest in the life of the creditor where, for example, the creditor has made a representation not to call in the debt during his or her lifetime provided such representation is binding ie. promissory estoppel (see, Central London Property Trust Ltd v High Trees House Ltd [1947] KB 130. See further, J Beatson, Anson’s Law of Contract (Oxford, OUP, 2002) at 112 et seq; S Worthington, Equity (Oxford, OUP, 2003) at 222–32); and JE Martin, Hanbury and Martin Modern Equity (London, Sweet & Maxwell, 2001) at 892 et seq). 3. While English courts have adopted a strict approach towards the categories of family relationships where insurable interest will be found to exist, the courts in most USA jurisdictions recognise ‘love and affection’ as the determinative test on the basis that such affinity adequately safeguards against any temptation to wilfully destroy life (see Mutual Savings Life Insurance Co v Noah, below, [715]; although note the dissenting judgment delivered by Jones J). There is, therefore, a significant body of dicta in US cases recognising the insurable interest of a minor in

the life of a parent and a parent in the life of a minor child (Rosenberg v Robbins 289 Mass 402, 194 NE 291 (1935); and National Life and Accident Insurance Co v Alexander 226 Ala 325, 147 So 173 (1933)). [715] Mutual Savings Life Insurance Co v Noah 291 Ala 444, 282 So.2d 271, 60 ALR 3d 81 (Supreme Court of Alabama) [William Noah had died by drowning. Donald Noah, the deceased’s brother, had taken out insurance policies on William’s life. Donald’s claim under the policies was rejected by the insurer]. Heflin CJ ‘The most divisive issue with which this court is faced is presented by appellant-respondent’s contention that Donald R Noah has no insurable interest in the life of the insured, and that each of the three policies was invalid by reason thereof… Under the evidence the two life policies were procured or “taken out” by the beneficiary, and thus the longestablished rule that the insurance is invalid unless the beneficiary has an “insurable interest” in the life of the insured applies. This rule is to the effect that a person has an unlimited insurable interest in his own life and may designate any person as his beneficiary so long as the insurance was procured or taken out by the insured and the premiums paid by him, but one taking out a policy of insurance for his own benefit, on the life of another person, must have an insurable interest in the continuance of the life of such insured…

Several reasons have been assigned as the basis for the insurable interest requirement, both of which are grounded upon public policy considerations: a policy taken out by one for his own benefit on the life of another, in whom he has no insurable interest is, in substance, a wagering contract; and such a policy may hold out a temptation to the beneficiary to hasten by improper means the death of the insured… Certain blood relationships have been held sufficient, in and of themselves to negate the supposition that the beneficiary would take out such a policy for the purpose of wagering on the insured’s death, or that such a policy would entice the beneficiary to take the insured’s life, and in such cases the relationship alone is said to create an insurable interest. This is true notwithstanding the fact that the beneficiary may have no reasonable expectation of pecuniary advantage through the continued life of the insured or consequent loss by reason of his death, which would otherwise be required in order to find an insurable interest. The relationship of husband and wife has been held to be sufficiently close to give either an insurable interest in the life of the other (Jennings v Jennings, 250 Ala 130, 33 So 2d 251). The parent-child relationship has been accorded the same status as that given to husband and wife in Jennings (Warnock v Davis, 104 US 775, 26 LEd 924; 44 CJS Insurance § 204). On the other hand, the following relationships have been held not to create an insurable interest on the basis of such relationship alone. Cousin and cousin (National Life & Accident Ins. Co v Alexander 226 Ala 325, 147 So 173); beneficiary has no interest in the life of the wife of his wife’s brother (National Life & Accident Ins. Co v Middlebrooks 27 Ala App 247, 170 So 84); aunt and niece (Commonwealth Life Ins. Co v George 248 Ala 649, 28 So.2d 910); aunt-inlaw and niece (Liberty National Life Ins. Co v Weldon 267 Ala

171, 100 So 2d 696); niece and uncle (Bell v National Life & Accident Ins. Co 41 Ala App 94, 123 So 2d 598). The specific issue presented in the case under review is whether one has an insurable interest in the life of his brother by virtue of the relationship alone. While realising that this issue is one of first impression in Alabama, and that other jurisdictions are in conflict on this matter, a review of the holdings of other states has convinced this court that the vast majority’ and best reasoned holdings support the proposition that the brother-brother relationship will, in and of itself, support an insurable interest. The reason most often assigned as the basis of a holding that such relationship will, in and of itself, support an insurable interest is that the natural love and affection prevailing between the two and the expectation that one will render the other aid in time of need is sufficient to overcome any wagering contract argument, as well as any impulse to hasten the death of the insured. This rationale was well stated in Century Life Ins. Co v Custer 178 Ark 304, 10 SW 2d 882 (1928), as follows: Brothers are so closely related that they are naturally interested in the preservation of the life of each other. Generally, they will lay down their life for each other. As a rule they care for each other in illness to the extent, if necessary, of furnishing all needed comforts and medicinal aid. It would be contrary to human nature for them to speculate on the death of each other, so it may well be that their contracts for insurance on the life of each other should not be classed as wagering contracts. Perhaps the facts of the instant case tend to contradict the closeness and mutual love and affection which the above holdings attribute to the brother-brother relationship, but this court does not write for this case alone. The holding of this court today will govern all future cases, not just the exceptional one where the natural love and affection

common to missing.’

the

brother-brother

relationship

may

be

Jones J, dissenting. ‘I must disagree with the majority holding that one has an insurable interest in the life of his brother (or sister) on the basis of their relationship alone…We know that the relationship of husband and wife constitutes such a relationship per se (Jennings v Jennings, [above]; and while I do not find that this Court has been specifically called upon to decide whether in every case the relationship of parent and child, or child and parent, in and of itself, with a presumption that is not even rebuttable, gives rise to an insurable interest in either, the overwhelming weight of authority is that this relationship is sufficient to constitute an insurable interest by one in the life of the other…But is the relationship of brothers in the same category, or does it depend upon the circumstances of the particular case?… In any case, I think that the relationship alone is not sufficient, that the rule requiring something other than the relation is the sound one and I would so hold. This is based on the rationale that there is but one test for insurable interest — that of a pecuniary interest or some reasonable expectation of monetary benefit from the continuance of the insured’s life; and within certain blood or affinity relationships this pecuniary interest or benefit is conclusively presumed. Such relationships are that of husband and wife, parent and child, grandparent and grandchild, and under certain conditions loco parentis relationships. This “conclusive presumption” rule with respect to these relationships does not violate the public policy necessitating insurable interest aimed at preventing homicide and wager contracts. While an extension of this rule to the brother relationship might be permissible as to the homicide aspect, to so extend this rule would facilitate

the violation of the second evil which the aforementioned public policy seeks to prevent; viz, wager contracts.x Having adopted the above view, I would hold that the line must be drawn short of the brother relationship, and that insurable interest in such cases should depend upon a pecuniary benefit, or advantage to be gained from the continued life of the insured, which cannot be conclusively presumed, but is subject to proof.’

Note: As commented above, much of the state legislation in the USA has adopted ‘love and affection’ as the determinative test for insurable interest. Further, as is the case in English law, the requirement of insurable interest is also satisfied where the insured has an economic interest in the continued existence of the life insured. [716] New York Insurance Law (1993) ‘§ 3205. Insurable interest in the person; consent required… (a) In this section: (1) The term, “insurable interest” means: (A) in the case of persons closely related by blood or by law, a substantial interest engendered by love and affection; (B) in the case of other persons, a lawful and substantial economic interest in the continued life, health or bodily safety of the person insured, as distinguished from an interest which would arise only by, or would be enhanced in value by, the death, disablement or injury of the insured.

(3) … (1) A wife or a husband may effectuate insurance upon the person of the other.’

[717] Mississippi Code of 1972 (as amended) ‘Section 83-5-251. Procurer of insurance must have insurable interest; insurable interest defined… (1) Any individual of competent legal capacity may procure or effect an insurance contract upon his own life or body for the benefit of any person, but no person shall procure or cause to be procured any insurance contract upon the life or body of another individual unless the benefits under such contract are payable to the insured or his personal representatives or to a person having, at the time when such contract was made, an insurable interest in the insured. (2) If the beneficiary, assignee or other payee under any contract made in violation of this section receives from the insurer any benefits from such contract accruing upon the death, disablement or injury of the insured, the insured or his executor or administrator may maintain an action to recover such benefits from the person so receiving them. (3) …“insurable interest” means that a person has an insurable interest in the life, body and health of another individual as follows: (a) The individual and the insured are related closely by blood or by law, a substantial interest engendered by love and affection; (b) The person has a lawful and substantial economic interest in having the life, health or bodily safety of the insured continue, as distinguished from an interest which would arise only by, or would be

enhanced in value by, the death, disablement or injury of the insured…’

Note: The Australian legislature has dropped requirement of insurable interest for life policies:

the

[719] (Australian) Insurance Contracts Act 1984 No. 80 (a amended) ‘Section 18 Insurable interest not required (1) This section applies to: (a) a contract of life insurance; or (b) a contract that provides for the payment of money on the death of a person by sickness or accident. (2) A contract to which this section applies is not void by reason only that the insured did not have, at the time when the contract was entered into, an interest in the subject-matter of the contract.’

7.4 The Consequences of Lack of Interest As has been seen, section 1 of the 1774 Act renders an insurance contract effected by a person without insurable interest illegal (Harse v Pearl (above, [710])). This aligns the position in insurance law with the general law in so far as to allow recovery of premiums where there is no insurable interest would violate the rule against enforcing illegal contracts. Such contracts are also void on the basis that they

were concluded under a mistake of law — ignorantia juris haud excusat — and are unlawful per se. The Law Commission Report, “Restitution: Mistakes of Law and Ultra Vires Public Authority Receipts and Payments” ((1994) Law Com No 227), had recommended that the mistake of law rule should be abrogated (paras 3.1 et seq and see clause 2 of the draft Bill appended to the report). It has now been held by the House of Lords that on the basis of the principle of unjust enrichment, money paid under a contract void for mistake of law may be recovered by way of a restitutionary claim. While the defence of change of position would technically be available to insurers it is unlikely that this would ever be the case. [720] Kleinwort Benson Ltd v Lincoln City Council [1999] 2 AC 349 (HL) [The facts are immaterial]. Lord Goff: ‘What is in issue at the heart of this case is the continued existence of a long-standing rule of law, which has been maintained in existence for nearly two centuries in what has been seen to be the public interest. It is therefore incumbent on your Lordships to consider whether it is indeed in the public interest that the rule should be maintained, or alternatively that it should be abrogated altogether or reformulated. Having said this, however, your Lordships are fully entitled to recognise that the local authorities are in truth adopting a realistic stance that, in the light of prolonged criticism of the rule by scholars working in the field of restitution, and of recent decisions by courts in other major common law jurisdictions, the case for

retention of the rule in its present form can no longer sensibly be advanced before your Lordships’ House. In these circumstances I do not have to consider this aspect of the case in as much depth as might otherwise be regarded as appropriate, though 1 have discovered that consideration of the case as a whole has cast light on the formulation of the limits to the right of recovery which lie at the heart of the case as presented to your Lordships’ House…

Conclusion on the first issue …I am satisfied that your Lordships should, if you decide to consider the point yourselves rather than leave it to the Law Commission, hold that the mistake of law rule no longer forms part of English law. I am very conscious that the Law Commission has recommended legislation. But the principal reasons given for this were that it might be some time before the matter came before the House, and that one of the dissentients in [Woolwich Equitable Building Society v IRC [1993] AC 70] (Lord Keith of Kinkel) had expressed the opinion that the mistake of law rule was too deeply embedded to be uprooted judicially…Of these two reasons, the former has not proved to be justified, and the latter does not trouble your Lordships because a more robust view of judicial development of the law is, I understand, taken by members of the appellate committee hearing the present appeals. Moreover, especially in the light of developments in other major common law jurisdictions, not to mention South Africa and Scotland, the case for abrogation is now so strong that the respondents in these appeals have not argued for its retention. In these circumstances I can see no good reason for postponing the matter for legislation, especially when we do not know whether or, if so, when Parliament may legislate. Finally, I believe that it would, in all the circumstances, be unjust to deprive the appellant bank of the benefit of the decision of the House on this point. I would therefore conclude on issue (1) that the mistake of

law rule should no longer be maintained as part of English law, and that English law should now recognise that there is a general right to recover money paid under a mistake, whether of fact or law, subject to the defences available in the law of restitution.’

Note: If Kleinwort Benson now represents the general position for insurance law, then if the facts of Harse (above, [710]) were to arise again, the son’s claim for a return of premiums would be successful.

7.5 Section 2 of the Life Assurance Act 1774: Inserting the Name of the Insured in the Policy Section 2 of the 1774 Act requires that the names of the insured together with any beneficiaries ‘interested’ in the insurance must be inserted in the policy document. Non-compliance with this provision renders the policy illegal: 2. No policies on lives without inserting the names of persons interested, etc And…it shall not be lawful to make any policy or policies on the life or lives of any person or persons, or other event or events, without inserting in such policy or policies the person or persons name or names interested therein, or for whose use, benefit, or on whose account such policy is so made or underwrote.

The rationale underlying section 2 is to prevent avoidance of section 1 (ie. the insurable interest requirement). The provision is little more than a technical requirement and serves little purpose (see J Lowry and P Rawlings, Insurance Law: Doctrines and Principles (Oxford, Hart Publishing, 1999). The difficulty which section 2 posed for group policies such as those effected by an employer in respect of employees where it is not possible to determine who will, from time to time, fall within the group was addressed by section 50 of the Insurance Companies Amendment Act 1973 which provides: (1) Section 2 of the Life Assurance Act 1774 (policy on life or lives or other event or events not valid unless name or names of assured etc. inserted when policy is made) shall not invalidate a policy for the benefit of unnamed persons from time to time falling within a specified class or description if the class or description is stated in the policy with sufficient particularity to make it possible to establish the identity of all persons who at any given time are entitled to benefit under the policy. (2) This section applies to policies effected before the passing of this Act as well as to policies effected thereafter.

In Feasey (above, [708]) Waller LJ, construing the meaning of section 2 of the 1774 Act as amended by section 50 of the 1973 Act, thought that it had the effect of removing the requirement that the names of the insured persons had to be inserted in a policy in circumstances where such persons were capable of meeting a given description. Further, they did not

have to be members of an identifiable class from the outset: ‘Parliament must be taken at least, following the amendment to section 2, not to have intended that section 1 would make null and void an insurance on lives of persons unidentified as at the date of the policy, but within a [given] description….’

The mischief that section 2 of the 1774 Act seeks to address is illustrated by Shilling v Accidental Death Insurance Co (1857) 2 H & N 42, where the premiums on a policy effected by a father on his own life were, in fact, paid by his son. It was held (Pollock CB, Martin, B, and Bramwell, B), that the insurance was the son’s who lacked insurable interest in the life of his father. Pollock CB stated that “this is a good plea under the 14 Geo 3, c 48, section 2. It avers the existence of a state of things which, if proved, would disentitle the plaintiff to recover. It appears that the policy was not in fact the policy of the person whose name appears on the face of it as being the person interested, or made for his benefit. It therefore comes within the prohibition contained in the second section of the act. There must be judgment for the defendants.” [721] Wainwright v Bland (1835) 1 Mood & R 481. [The insured, Miss Abercromby, effected a policy on her own life in her own name. She did this on the persuasion of Wainwright, the plaintiff, who was

married to her sister. The insured lodged with them. Previously she had taken out a number of other life policies amounting to some £11,000, two of which had been assigned to Wainwright just before her death. The insured died on the 21 December 1830, having executed a will the week before her death. She bequeathed the insurance proceeds to her sister and had appointed Wainwright as her sole executor. On the evidence, it was apparent that the insured could not afford the premiums herself but had paid them with money supplied by the plaintiff. It is evident that the court was suspicious that the insured had been murdered by Wainwright (indeed there is some evidence that he had murdered his grandfather and mother-in-law by strychnine poisoning). The jury decided that the policy was invalid]. Lord Abinger CB (addressing the jury): ‘[T]he question in this case is, who was the party really and truly effecting tile insurance? Was it the policy of Miss Abercromby? Or was it substantially the policy of Wainwright the plaintiff, he using her name for the purposes of his own? If you think it was the policy of Miss Abercromby, effected by her for her own benefit, her representative is entitled to put it in force; and it would be no answer to say that she had no funds of her own to pay the premiums; Wainwright might lend her the money for that purpose, and the policy still continue to be her own. But, on the other hand, if, looking to all the strange facts which have been proved before you, you come to the conclusion that the policy was, in reality, effected to Wainwright; that he merely used her name, himself finding the money, and meaning (by way of assignment, or by bequest, or in some other way), to have the benefit of it himself; then I am of opinion such a

transaction would be a fraudulent evasion of the statute 14 Geo III, c 48, and that your verdict should be for the defendants.’

Notes: 1. The (Australian) Insurance Contracts Act 1984 No. 80 (as amended) abolishes the requirement of naming the beneficiary in the policy: Section 20 Naming of persons benefited An insurer under a contract of insurance is not relieved of liability under the contract by reason only that the names of the persons who may benefit under the contract are not specified in the policy document.

2.

Notwithstanding the array of decisions considered above, in practice insurers rarely raise lack of interest as a defence for the expedient reason that adverse publicity would result where the insurer has had the benefit of the premiums. Indeed, in Feasey (above, [708]) the Court of Appeal was unanimous in holding that in a commercial transaction the court should lean in favour of finding insurable interest. Indeed, Waller LJ was critical of the insurers raising the issue at all: ‘It is not attractive to contemplate that where insurers have carefully crafted a policy which was intended to be enforceable by Steamship, a point on insurable interest could arise’ (as to the reluctance of the judiciary to allow insurers to resist a claim by relying on a technical

absence of interest, see chapter 6, particularly Ward LJ’s judgment in Feasey).

7.6 Privity and Third Party Rights in Life Assurance The Married Women’s Property Act 1882 provides for the creation of a statutory trust the effect of which is that on the death of the insured the insurance proceeds will go directly to the surviving spouse and/or children and will not, therefore, form part of the insured’s estate. The insured is a trustee of the policy and is thus subject to the duties imposed on trustees to act in the best interests of the beneficiaries. The statutory trust is a useful device for avoiding inheritance tax on the one hand, and avoiding the claims of creditors on the other. [722] Married Women’s Property Act 1882 (45 & 46 Vict, c 75) ‘Section 11 Moneys payable under policy of assurance not to form part of estate of the insured A married woman may effect a policy upon her own life or the life of her husband for her own benefit and the same and all benefit thereof shall enure accordingly. A policy of assurance effected by any man on his own life, and expressed to be for the benefit of his wife, or of his children, or of his wife and children, or any of them, or by any woman on her own life, and expressed to be for the benefit of her husband, or of her children, or of her husband and children, or any of them, shall create a trust in favour of

the objects therein named and the moneys payable under any such policy shall not, so long as any object of the trust remains unperformed, form part of the estate of the insured, or be subject to his or her debts: Provided, that if it shall be proved that the policy was effected and the premiums paid with intent to defraud the creditors of the insured, they shall be entitled to receive, out of the moneys payable under the policy, a sum equal to the premiums so paid. The insured may by the policy, or by any memorandum under his or her hand, appoint a trustee or trustees of the moneys payable under the policy, and from time to time appoint a new trustee or new trustees thereof, and may make provision for the appointment of a new trustee or new trustees thereof, and for the investment of the moneys payable under any such policy. In default of any such appointment of a trustee, such policy, immediately on its being effected shall vest in the insured and his or her legal personal representatives, in trust for the purposes aforesaid. The receipt of a trustee or trustees duly appointed, or in default of any such appointment, or in default of notice to the insurance office, the receipt of the legal personal representatives of the insured shall be a discharge to the office for the sum secured by the policy, or for the value thereof, in whole or in part.’

8 Contractual Terms 8.1 Introduction As with non-insurance contracts, for example contracts for the sale of goods, not all terms in a policy of insurance will be of equal importance to the parties. The basic classification of terms into ‘conditions’ or ‘warranties’ that has long been adopted in the general law of contract is also followed in insurance. In general contract law conditions are viewed as fundamental terms which are promissory in nature (‘the breach of which may give rise to a right to treat the contract as repudiated’: Sale of Goods Act 1979, section 11(3)); and warranties are viewed as subsidiary promises which are collateral to the contract, the breach of which gives rise to a claim in damages only. However, in insurance contracts the classification is reversed so that warranties are treated as fundamental terms (‘[a] warranty…is a condition which must be exactly complied with, whether it is material to the risk or not. If it be not so complied with…the insurer is discharged from liability’: Marine Insurance Act 1906,

section 33(3)). As is apparent from the language of the 1979 and 1906 statutes, the distinction between the general law of contract and insurance goes beyond mere terminology but also relates to the consequences that flow from a breach of a fundamental term (see below).

8.2 Defining and Creating an Insurance Warranty In De Hahn v Hartley (1786) 1 TR 343, Ashurst J stated that ‘the very meaning of a warranty is to preclude all questions whether it has been substantially complied with; it must be literally so.’ Similarly, Lord Eldon LC remarked in Newcastle Fire Insurance Co v Macmorran & Co (1815) 3 Dow at 262, that: ‘it is a first principle in the law of insurance, on all occasions, that where a representation is material it must be complied with — if immaterial, that immateriality may be enquired into and shown; but if there is a warranty it is part of the contract that the matter is such as it is represented to be. Therefore the materiality or immateriality signifies nothing. The only question is as to the mere fact.’ The Law Commission Report No 104 (1980), NonDisclosure and Breach of Warranty, defines a warranty as ‘a term of the [insurance] contract which must be strictly complied with…The meaning of warranty in insurance law is thus similar to the meaning of ‘condition’ in the law of sale of goods.

The promise which forms the subject-matter of a warranty consists of an undertaking by the insured that some particular thing shall or shall not be done or whereby he affirms or negatives the existence of a particular state of facts.’ The New York Insurance Law Code § 3106 defines a warranty as ‘any provision of an insurance contract which has the effect of requiring, as a condition of the taking effect of such contract or as a condition precedent of the insurer’s liability thereunder, the existence of a fact which tends to diminish, or the non-existence of a fact which tends to increase, the risk of the occurrence of any loss, damage or injury within the coverage of the contract.’ A warranty is thus defined by reference to whether it relates to ‘potential causes’ as opposed to ‘actual causes’ (as is the case with terms descriptive of risk (below)): see Edwin W Patterson, Essentials of Insurance Law (New York, McGraw Hill, 1957) at 275; (the distinction is illustrated by Kler Knitwear Ltd v Lombard General Insurance Co Ltd [2000] Lloyd’s Rep IR 47 (below, [819])). No particular form of words is required to create a warranty and simply labelling a term as a warranty is not conclusive of the issue. The critical factor is that the language must unequivocally point to the intention of the parties to create a fundamental term, the breach of which will terminate the contract: ‘any statement of fact bearing upon the risk…[is] to be construed as a warranty, and prima facie, at least that the compliance with that warranty is a condition precedent to the attaching of the risk.’ It is evident

from this passage taken from Lord Blackburn’s speech delivered in Thomson v Weems (1884) 9 App Cas 671, that the judges adopt the term ‘condition precedent’ to describe a warranty that relates to the risk and which is precedent to the insurer’s liability. In this respect, section 33(3) of the Marine Insurance Act 1906, which codified the common law, is so framed as to reflect ‘the inveterate practice…of using the term “warranty” as signifying a condition precedent’: per Lord Goff, The Good Luck [1992] 1 AC 233 (below, [820]). [801] The Law Commission Report No 104 (1980), Non-Disclosure and Breach of Warranty, para 6.3: ‘Creation of warranties A warranty may be created in one of the following ways: (a) by the use of the word “warranty”; for example, “the insured warrants…”; (b) by an express provision for strict compliance and the right to repudiate for breach; (c) by the use of a phrase such as “condition precedent” from which the court can infer that the parties intended strict compliance and the right to repudiate for breach; (d) by the use of any other words such that the court concludes that, on the true construction of the whole document containing the term, the parties intended the term to possess the attributes of a warranty; (e) by the use of a “basis of the contract” clause.

Notes:

1. As will be seen (below, [819]), it is now settled that a breach of warranty automatically discharges the insurer from liability (Bank of Nova Scotia v Hellenic Mutual War Risks Association (Bermuda) Ltd, The Good Luck [1992] 1 AC 233 (HL)). (Prior to the decision in The Good Luck the prevailing view was that an insured’s breach of warranty entitled the insurers to repudiate the contract). 2. In terms of a particular claim, therefore, the effect of a breach of warranty carries dire consequences for the insured. The courts have thus adopted a strict approach when called upon to determine whether a particular term is fundamental to the contract by enlisting the contra proferentem canon of construction. The practical effect is that the courts lean in favour of policyholders. Note the strident criticism of the insurers voiced by MacKinnon J in Roberts: [802] Roberts v Anglo-Saxon Insurance Association Ltd (1926) 26 Ll L Rep 154 [While the insured’s car was carrying passengers on a pleasure trip it caught fire and was destroyed. The insurers repudiated the claim on the basis that the insured had warranted that the vehicle would be used only for commercial traveling. The arbitrator, finding in favour of the insured, held that the carrying of passengers in no way caused the fire, and that the ‘warranty’ in question did not go to the root of the transaction between the parties].

MacKinnon J: ‘…The contention on behalf of the insurance company is that there is contained in this contract a stipulation which, if written out in perfectly plain language, would be to this effect: “It is a condition of this policy that this car shall at every moment be used for commercial travelling, and if on any similar occasion it is used for any other purpose, the validity of the policy shall instantly cease.” Now it has been long settled that an insurance company which desires for its own protection to insert a provision of that nature or indeed any provision or limitation of its liability must do so in plain terms, and an ambiguous provision affords them no protection. When I turn to the policy I see that the operative part of it is this: “It is hereby agreed as follows: That the Association will indemnify the insured in respect of any motor vehicle, the property of the insured, and described in the Schedule thereto.” — leaving out some immaterial words — “subject to the provisions, conditions and definitions herein contained and to any memorandum endorsed hereon.” The promise there is to insure a certain described schedule subject to certain provisions and definitions “on any memorandum endorsed.” There is no memorandum endorsed, so that that may be left out. The “conditions” are clearly put under a headline on the back of the policy. The “definitions” are contained under a headline at line 52 of the policy. There is no headline to any provisions, but one may reasonably conclude that provisions are referred to between lines 27 to 51, which has a heading “General exclusions.” Now, those are the provisions, conditions and definitions subject to which the promise to pay is contained.

There is a further reference in this operative part of the policy to the car, “described in the schedule hereto,” and it is in that schedule that the words occur which are relied upon as constituting this warranty or condition. Quite clearly the schedule which is referred to as described in the policy is the thing headed: “Schedule — Particulars of motor vehicles insured,” and which is the headline over certain printed matter enclosed in lines forming a square. The other part of it is with regard to the description of the car which includes, among other things, the fact that it has five seats. No one could for a moment suppose that if during the course of the policy the man altered the body and turned it into a two-seater car, the validity of the policy would then cease. There then follows as part of that schedule of description: “Warranted used only for the following purposes — Commercial travelling.” Now, nothing turns upon the word “warranted”; the word “warranted” is always used with the greatest possible ambiguity in a policy. Because a phrase begins with the word “warranted” in a policy it does not by any means mean that that is a condition. In a marine policy of insurance it is the usual thing to warrant for particular average. It simply means: “We shall not pay for partial loss.” In my judgment the words there appearing in part of that schedule specified as the description of the policy are by no means sufficiently clear to entitle the insurance company to say that they amount to a condition to the effect that I have indicated, namely, that if ever the car is used, for instance, to carry a wounded person to hospital, the validity of the whole policy shall at once cease. Presumably the Anglo-Saxon Insurance Company, if it is to live up to its name, can express its meaning in English, in perfectly clear terms, and if they desire to put in a condition to the effect suggested, I think they must do so in perfectly clear Anglo-Saxon, the result of which I should suppose would be that an increasingly small number of people would desire to insure with them.

I agree that the motion should be dismissed with costs.’ See also, CTN Cash and Carry v General Accident [1989] 1 Lloyd’s Rep 299 (below, [817]).

[803] Provincial Insurance Company Morgan [1933] AC 240 (HL)

Ltd

v

[The facts appear from Lord Buckmaster’s speech]. Lord Buckmaster: ‘My Lords, the question on this appeal depends upon the true construction of a policy of insurance issued by the appellants in favour of the respondents insuring them against liability to the public for damage caused by the use of a motor vehicle. The insurance was consequent upon a proposal form which was signed by the respondents in March of 1931. In that form there was a statement in the following words: “State (a) the purposes in full for which the vehicle will be used; and (b) the nature of the goods to be carried.” The answer was (a) “delivery of coal”; (b) “coal.” At the foot of the proposal form and above the respondents’ signature was a statement in the following words: — “I hereby declare and warrant that the above questions are fully and truthfully answered, that I have not withheld or concealed any circumstance affecting in any way the proposed insurance, and that the vehicles described are in good condition. I agree that this declaration and the answers above given shall be the basis of the contract between me and the Provincial Insurance Co., Ltd., and I agree to accept a policy subject to the conditions prescribed by the Company and expressed in the policy.” The policy which was subsequently issued referred to the proposal and declaration which it was agreed should be deemed to be of a promissory nature and effect and should

be the basis of the contract for the insurance thereby intended. The policy itself provided that the indemnity should be subject to the exclusions and conditions therein set out, and one of those conditions was condition 6: — “It is a condition precedent to any liability on the part of the Company under this policy: (i) that the terms, provisions, conditions and endorsements hereof, so far as they relate to anything to be done or complied with by the insured, are duly and faithfully observed; and (ii) that the statements made and the answers given in the proposal hereinbefore referred to are true, correct and complete.” …The respondents in fact did use their cart for hauling timber of the Forestry Commission in pursuance of a verbal contract to that effect and had so used it on the day when an accident occurred. But the finding of fact is clear that the claimants were engaged in the business of delivering coal when the accident arose, and it is not suggested that this was not in general terms the use to which the vehicle was put. The appellants have repudiated liability under the contract upon the ground that the use of the lorry for a purpose other than that of carrying coal was a breach of the statement as to the purpose for which the vehicle was to be used, and as this was made the basis of the contract the risk has never attached. Now it is old and well known law that parties to an insurance contract are at liberty to contract upon the footing that any statement can be made the basis of the contract, and if the statement be inaccurate its materiality does not arise… Turning, therefore, back to the words in the present case, the question that arises is, were these words intended to mean that the use of the vehicle was to be exclusively confined to that of carrying coal, so that any temporary, trivial, and incidental use would completely defeat the policy, or was it not? I wish again to repeat that it is

perfectly open to people to make such a bargain, and when made it is useless to complain that the bargain is harsh. But it is at least essential that the bargain should be plain in order that it may be clear that a man has contracted on the faith of something which may rob the insurance of the greater part of its value. It is said here that the insurance was at a lower rate because it was a coal cart; and that may be so, but that does not help the question on the one side or the other. To state in full the purposes for which the vehicle is to be used is not the same thing as to state in full the purposes for which the vehicle will be exclusively used, and as a general description of the use of the vehicle it is not suggested that the answer was inaccurate. I am therefore of opinion that there was no bargain here so to confine the use of the vehicle to the cartage of coals as to make any occasional use that did not destroy the general purpose of its user a breach of the condition upon which the policy was based…’

Lord Russell: ‘My Lords, it appears to me that the result of this appeal depends solely upon the true construction of the documents… The foundation of [the insurers] contention is as follows: The proposal form requires the proposer (amongst other things) to state (a) the purposes (in full) for which the vehicle will be used, and (b) the nature of the goods to be carried. The proposers stated: (a) Delivery of coal; (b) coal: and they signed a declaration that the questions were fully and truthfully answered. The policy refers to the proposal and declaration which (it provides) shall be deemed to be of a promissory nature and effect and shall be the basis of the contract as if incorporated in the policy. [His Lordship read Condition 6, see Lord Buckmaster’s speech, above]… It is contended by the appellants that the statement above referred to constituted a statement: (a) that during

the currency of the policy the vehicle would never be used for any purpose other than the delivery of coal; and (b) that during the currency of the policy coals, and coals only, would be carried in the vehicle. They then say that these statements are incorporated into the policy as contractual provisions relating to something to be done or complied with by the insured, the due and faithful observance of which is under condition 6 a condition precedent to any liability on the part of the insurance company; and that the vehicle having in fact been used during the currency of the policy for the purpose of carrying timber, no liability can attach to the insurance company. Alternatively it was said that the answer given in the statement was not true, correct, or complete because the vehicle had in fact subsequently carried timber, with the result of freeing the insurance company from liability under the second part of condition 6. This argument in my opinion breaks down at the outset. I cannot read the above statements in the proposal form as being more than statements by the proposers of their intentions as to the user of the vehicle and the goods to be carried in it, and so as descriptive of the risk. If it had really been the intention of the insurance company that the carrying of goods other than coal at any time should free them from liability in respect of an accident happening subsequently, it was incumbent on them to make that abundantly clear to the proposers. On the construction which I give to the statement there is no scope for the operation of condition 6 in favour of the insurance company. It is not shown that there has been any failure of the insured to observe any provision relating to anything to be done or complied with by them, or that their answers were not true, correct, and complete…’

[804] Wood v The Hartford Fire Insurance Co 13 Conn 533, 35 Am Dec 92 (1840)

Sherman J: ‘The general rule in regard to what constitutes a warranty, in a contract of insurance, is well settled. Any statement or description, or any undertaking on the part of the insured, on the face of the policy, which relates to the risk, is a warranty. Whether this is declared to be a warranty totidem verbis or is ascertained to be such, by construction, is immaterial. In either case, it is an express warranty, and a condition precedent. If a house be insured against fire, and is described in the policy as being “cooper roofed,” it is as express a warranty, as if the language had been, “warranted to be copper roofed”; and its truth is as essential to the obligation of the policy, in one case as in the other. In either case, it must be strictly observed. There may often be much difficulty in ascertaining from the construction of the policy, whether a fact, quality or circumstance specified, relates to the risk, or is inserted for some other purpose — as to shew the identity of the article insured…This must be settled, before the rule can be applied. But when it is once ascertained, that it relates to the risk, and was inserted in reference to that, it must be strictly observed and kept… In the policy, this establishment is described as “the one undivided half of the paper-mill, which they [the insured] own at Westville, together with the half of the machinery wheels, gearing, etc; the other half being owned by William Buddington.” If this relates to the risk, it is a warranty. That it does, is evident from the memorandum in the conditions of the policy, where “paper-mills” are enumerated among those articles which “will be insured at special rates of premium”; that is, a paper-mill is the subject of peculiar risks, and is to be insured upon special stipulations. Therefore, the description of this, in the policy, as a “papermill,” relates to the risk, and is, consequently, a warranty. It is the only subject of insurance; and, if it was not a papermill, at the time of the loss, the warranty was not kept, and the plaintiffs cannot recover, although the change may have

diminished the hazard, and been effected without their knowledge or against their will. It is contended, that the paper-mill had become converted into a grist mill. The policy is dated in February 1837. In the August, following, the use of the paper-mill was discontinued, and a pair of mill-stones were added, for grinding grain. They were located in the place previously occupied by the rag-cutter and duster; and were moved by the same gearing, and by the power of the same waterwheel. No other machinery was used for the grindstones. All remained as it was, except the rag-cutter and duster — which were dismounted and all the other machinery might, at any time, have been employed in making paper. It was, to all intents and purposes a paper-mill, ready for use. The character of the establishment was no more altered, than if a grindstone had been attached, by a band, to the waterwheel and all the other machinery left at rest. The warranty was duly kept.’ Judgment for plaintiffs.

Notes: 1. The terms in a typical insurance contract are, of course, found in the policy document. But this will commonly incorporate the answers given by the insured to the questions contained in the proposal form together with any provisions in renewal notices or other instruments sent out by the insurer. Constructing insurance contracts by means of incorporating terms from different documents has not escaped judicial criticism. For example, in Provincial Insurance Company Ltd v Morgan (above, [803]), Lord Wright stridently condemned this practice on the basis

that ‘it must be very confusing to the assured’ who may find himself deprived of cover ‘because he has done something quite innocently but in breach of a condition, ascertainable only by the dovetailing of scattered portions.’ 2. As noted by the Law Commission (see para 6.3, above [801]) insurers commonly sought to convert the insured’s answers in the proposal form into warranties by the so-called ‘basis of the contract clause’. Notwithstanding the criticism of this practice by the Law Commission (see below, [831]), Parliament has so far failed to intervene. (For judicial criticism, see Lord Wrenbury’s speech in Glicksman v Lancashire and General Assurance Co Ltd (see chapter 4, [419]). From the insured’s perspective basis of contract clauses can give rise to particularly harsh results. 3. Contrast the approach of the Supreme Court of Connecticut in Wood (above, [804]) with that of the House of Lords in Dawsons Ltd v Bonnin: [805] Dawsons Ltd v Bonnin [1922] 2 AC 413 (HL) [The appellants, a firm of removal contractors carrying on business at 46 Cadogan Street, Glasgow, insured a lorry against damage by fire and third party risks. The policy stated that the proposal should be the basis of the contract and incorporated into the policy. It also stated that the policy was subject to the

conditions set out on its reverse. The fourth condition provided that a “material misstatement or concealment of any circumstance by the insured material to assessing the premium herein, or in connection with any claim, shall render the policy void.” In response to a question in the proposal form, “State full address at which the vehicle will usually be garaged,” the insured inadvertently answered: “Above Address,” ie. the insured’s ordinary place of business in Glasgow. This was not true because the lorry was usually garaged at a farm (Dovehill) on the outskirts of Glasgow but within the city itself. The lorry was destroyed by fire at Dovehill and the insured claimed payment under the policy]. Viscount Haldane: ‘The question in the appeal is whether the respondents were freed from liability under the policy by reason of inaccuracy in a statement made by the appellants in the proposal submitted when the policy was issued, to the effect that the motor would usually be garaged at a certain address, whereas it was garaged elsewhere… My Lords, the reply of the appellants, the insured, on this point was that the question whether the motor vehicle was to be stored at Dovehill or at Cadogan Street was not a material one. The chief risks covered by the policy were in the main wholly unconnected with fire at the garage, and the percentage of the premium to be allocated to that risk was very small. The respondents called evidence to prove that they did consider that the question was one of importance, and the learned judges in the Court below appear to have given credence to that evidence and to have attached weight to it. This is an important fact, and I am reluctant to differ from them. But I think that,

notwithstanding some differences in the way in which they cross-examined the witnesses called for the respondents, the appellants have sufficiently proved by testimony which commends itself that in all probability no importance would have been attached to any answer to the fourth question in the proposal form to the effect that Dovehill was to be the place of garage. But that does not dispose of the case. For if the respondents can show that they contracted to get an accurate answer to this question, and to make the validity of the policy conditional on that answer being accurate, whether the answer was of material importance or not, the fulfilment of this contract is a condition of the appellants being able to recover. My Lords, for this reason it appears to me that the question which really lies at the root of the matter in dispute is one of construction simply…If there are statements in the answers to the questions in the proposal form which are in this way constituted by special stipulation conditions, they are therefore unaffected by the subsequent and independent condition dependent on materiality. Now as to the character of such conditions, and as to what is implied in their constitution, there is a good deal of authority which is instructive. It is worthwhile to consider how the distinction between a condition and a representation came to be drawn in this connection. The distinction had its origin in the historical development of the law of England, but, as Lord Watson observed of the existing state of the law, the doctrine of warranty as applied to such stipulations in a contract of assurance is the same in the law of Scotland as in that of England: Thomson v Weems (1884) 9 App Cas 671…“Warranty” is a somewhat unfortunate expression to have been used in this connection. The proper significance of the word in the law of England is an agreement which refers to the subject matter of a contract, but, not being an essential part of the contract either

intrinsically or by agreement, is collateral to the main purpose of such a contract. Yet irrespective of this the word came to be employed in England when what was really meant was something of wider operation, a pure condition. If goods tendered in performance of a contract do not satisfy the conditions stipulated for, the buyer may reject them; but he may alternatively accept the goods and claim damages for breach of the stipulated condition, thus treating his claim as one for damages for a breach of warranty, sufficiently so constituted. The condition is thus wider than the warranty strictly so called, but may sometimes be founded on as giving rise to a contract of warranty. In this way the restricted limits of the English common law encouraged the development of the notion of warranty in a fashion which would not have been required in Scotland, where law and equity were never severed. In England it was always possible to set aside a contract for misrepresentation, but the representation, although sufficient for the jurisdiction even though perfectly innocent, had to be material. Moreover, at common law it was no defence to an action on a contract that there had been misrepresentation, unless the misrepresentation were fraudulent or of a recklessness analogous to fraud: see the judgment of Jessel MR in Redgrave v Hurd (1881) 20 Ch D 1, 13. Possibly in order to provide for the difficulty occasioned by the limits of their jurisdiction, the Courts of common law showed great readiness to construe a representation sufficiently expressed to be the foundation for the acceptance of a proposal made by a would-be insured to an insurer as a condition which, if accepted, had to be observed independently of any question of materiality. As Lord Blackburn observed in Thomson v Weems…: “It is competent to the contracting parties, if both agree to it and sufficiently express their intention so to agree, to make

the actual existence of anything a condition precedent to the inception of any contract; and if they do so the nonexistence of that thing is a good defence. And it is not of any importance whether the existence of that thing was or was not material; the parties would not have made it a part of the contract if they had not thought it material, and they have a right to determine for themselves what they shall deem material.” He goes on to point out that in policies of marine insurance it is settled that any statement of a fact bearing on the risk is, “by whatever words and in whatever place, to be construed as a warranty, and, prima facie, at least, that the compliance with that warranty is a condition precedent to the attaching of the risk.” Without going so far as to hold that this rule is also applicable to the construction of life policies generally, he thought that it applied to the life policy before him, and “when we look at the terms of this contract, and see that it is expressly said in the policy, as well as in the declaration itself, that the declaration shall be the basis of the policy, that it is hardly possible to avoid the conclusion that the truth of the particulars (which, I think, include his statement that he was of temperate habits) is warranted”… As to the fourth of the appended conditions, this, as I have already observed, extends to matters which go beyond in some respects, and are outside in other respects, those dealt with specifically in the proposal form. Moreover, the fourth condition is limited to what is “material to assessing the premium,” and I will assume for present purposes that nothing material in this sense was misstated or concealed. If so, that fourth condition does not apply. But on the other hand I do not find in the language used in it anything which cuts down or interferes with the effect of the fourth of the answers in the proposal form, if this in itself imports a condition. If it does import by itself a condition, then I think

that, as Lord Blackburn laid down in the passage quoted, it imports a condition which must be shown to have been complied with, whether material from an ordinary business standpoint or not. It is clear that the answer was textually inaccurate. I think that the words employed in the body of the policy can only be properly construed as having made its accuracy a condition. The result may be technical and harsh, but if the parties have so stipulated we have no alternative, sitting as a Court of justice, but to give effect to the words agreed on. Hard cases must not be allowed to make bad law. Now the proposal, in other words the answers to the questions specifically put in it, are made basic to the contract. It may well be that a mere slip, in a Christian name, for instance, would not be held to vitiate the answer given if the answer were really in substance true and unambiguous. “Falsa demonstratio non nocet.” But that is because the truth has been stated in effect within the intention shown by the language used. The misstatement as to the address at which the vehicle would usually be garaged can hardly be brought within this principle of interpretation in construing contracts. It was a specific insurance, based on a statement which is made foundational if the parties have chosen, however carelessly, to stipulate that it should be so. Both on principle and in the light of authorities such as those I have already cited, it appears to me that when answers, including that in question, are declared to be the basis of the contract this can only mean that their truth is made a condition exact fulfilment of which is rendered by stipulation foundational to its enforceability…’

Viscount Finlay (dissenting): ‘…There remains for consideration only the defence raised in the second answer and in the first and fourth pleas in law for the defenders. The second answer contained the following averment: “In the proposal which is the basis of

the policy, the following question and answer occur ‘State full address at which the vehicles will usually be garaged.’ (A.) ‘Above address’ (which was 46 Cadogan Street, Glasgow). The said answer is untrue and misleading. The information requested and given was of material importance to the defenders in considering the said proposal, and they contracted on the faith that the answer was true. In consequence of its falsehood, the policy is void.” The first plea in law for the defenders was this: “1. The policy is void because of the untrue answer given to the question in the proposal referred to in Answer 2 hereof, and because the information contained in said answer was material to the formation of the contract, and misled the defenders on a material matter.” The fourth plea in law was the following: “4. The proposal of the pursuers being false and misleading with reference to the place where the motor car insured would be garaged, the defenders are entitled to absolvitor”… The proposal form contained a description of the vehicle to be insured and the answers to which I have already referred. The policy itself recites the proposal and says that it is to “be the basis of the contract and be held as incorporated herein.” The underwriters bound themselves to indemnify the assured subject to the conditions on the back as against certain perils, including loss by fire. The fourth of the conditions on the back is this: “4. Material misstatement or concealment of any circumstances by the insured material to assessing the premium herein, or in connection with any claim, shall render the policy void.” It was urged on behalf of the respondents that the statement of the usual place of garage was a warranty in the sense in which that term is used with reference to contracts of insurance, and that if it was not correct the action must fail, whether the statement was material or not in itself. The Lord Ordinary held that this statement was such a warranty, and, in his interlocutor of 15 July 1920,

found that the policy “is void because of the untrue answer given to the question in the proposal.” On appeal the Second Division also decided in favour of the underwriters, the respondents in the present appeal, but on grounds entirely different from that on which the Lord Ordinary had proceeded. They held that the fourth condition indorsed on the policy applied, and that the policy was void, because the answer in the proposal form contained a material misstatement by the assured of circumstances material to assessing the premium on the policy. I agree with the Second Division that the case is governed by the fourth of the indorsed conditions. I am unable to agree with them in the view that the statement as to the garage was material to assessing the premium on the policy, and if I am right in this view it will follow that the appeal should be allowed and judgment entered for the appellants. I am wholly unable to adopt the view on which the Lord Ordinary proceeded that the clause amounted to a warranty. The expression “warranty” imports that a particular state of facts in the present or in the future is a term of the contract, and, further, that if the warranty is not made good the contract of insurance is void. It is not necessary that the term “warranty” should be used, as any form of words expressing the existence of a particular state of facts as a condition of the contract is enough to constitute a warranty. If there is such a warranty the materiality of the facts in themselves is irrelevant; by contract their existence is made a condition of the contract. But if the language used is not clear the materiality or immateriality of the facts said to be warranted may be an element in arriving at a conclusion on the question whether the language used should be construed as constituting a warranty. In the present case it appears to me that the evidence establishes that the statement as to the garage was not material to the present insurance. In the case of an ordinary

policy covering a motor against fire risk the question of the garage might be very material. Its structure and locality might affect the chances of fire or the chance of fire being extinguished if it should break out, but as to the present policy, the evidence of the pursuers’ witnesses, Olden, Stewart and Ballantyne, is quite distinct that the risk of fire in the garage is so insignificant in comparison with the other risks insured, which are those of the road, including fire on the road, which might result from self-ignition, that it is ignored in fixing the premium. It is true that the evidence of the defenders, upon whom lay the onus probandi, had been taken before the evidence for the pursuers, and it is said, and I think with justice, that the cross-examination of the defenders’ witnesses on this point was insufficient. The defenders, however, did not object on this ground to the reception of the pursuers’ evidence on the point, and, further, the defenders, if they had been in a position to controvert the pursuers’ evidence, might have applied to be allowed to adduce evidence on the point which had been so clearly developed in the evidence of the pursuers’ witnesses. They made no such application, and for this there can be only one reason — namely, that they were not in a position to controvert the truth of the evidence given by the pursuers’ experts. We must therefore take the evidence as it stands, with the result that there is no contradiction of the pursuers’ evidence on this point. If the risk of fire in the garage did not affect the premium it could not be material. It would require clear language in the policy to establish that a statement of an immaterial point of this nature had been made a condition of the policy by warranty. The very usual clause making the truth of the answers in the proposal a condition of the policy, so that it is void if they are in any respect untrue, does not occur in the present policy, and the fact that such a clause is usual cannot be ignored in determining whether a policy in which it is absent amounts to a warranty.

The respondents are therefore driven to rely solely upon the clause in the policy that the proposal should be the basis of the contract and be held as incorporated therein. This clause appears to me to be inadequate to support the conclusion which the respondents desire to draw from it. The proposal is no doubt the basis of the contract of insurance in the sense that it initiated the transaction and that in response to it the insurance was granted. But this does not in the least involve the proposition that any inaccuracy on any point in any of the answers, however immaterial, would be fatal to the policy. If the statement were material to the risk it might be another matter altogether. The policy is put forward by the underwriters and it must be construed contra proferentes. If its effect is ambiguous it must be read in favour of the assured. The existence of the fourth condition indorsed on the policy tends strongly to show that the answer as to the garage should not be read as a warranty. The fourth condition is one subject to which the contract of insurance came into existence, and it is an integral part of the contract. On the fair reading of the contract as a whole, including the fourth condition, the inference seems to me irresistible that it was only material misstatements, whether in the proposal or elsewhere, that were to render the policy void… The case really falls to be determined on the fourth of the indorsed conditions, and as the misstatement was not material to the question of premium, the appeal, in my opinion, should be allowed.’

[806] Unipac (Scotland) Ltd v Aegon Insurance Co (UK) Ltd (1999) Lloyd’s Rep IR 502 [A proposal form for fire insurance contained two incorrect answers. The first concerned the length of

time the insured had carried on business at the premises. The second concerned whether the insured was the sole occupier. The insured had signed the following declaration: “We declare that to the best of our knowledge and belief all statements and particulars contained in this proposal are true and complete and that no material fact has been withheld or suppressed. We agree that this proposal shall be the basis of the contract between us and the insurers.”

A fire damaged the premises and the insurers repudiated liability. The insured argued the first sentence of the declaration was no more than a declaration that no material fact had to the best of their knowledge and belief been concealed in respect of matters to which the questions in the proposal form had been directed]. Opinion of the court: ‘[W]e are not persuaded that there is any ambiguity in the declaration. On the contrary, we are satisfied that the meaning of the declaration is clear. The statement in the first part of the second sentence, to the effect that the proposal is to be the basis of the contract, makes it perfectly plain that the answers contained in the proposal are warranted as being true and complete…We see no reason why the second clause of the first sentence should be treated as qualifying the words contained in the first clause. We accept that there may be cases where the context requires that subsequent provisions should be construed as qualifying or explanatory of what has gone before… In our opinion, the first sentence in the declaration is dealing with two separate matters. The first clause, when

read along with the provision in the second sentence to the effect that the proposal is to be the basis of the contract, clearly contains a warranty of the truth of the answers given to the questions in the proposal form. The second part of the first sentence is dealing with a different matter, namely the obligation not to withhold or suppress material facts. No doubt that is a repetition of what would be implied at common law, but there is nothing to prevent parties from choosing in a contract to repeat a provision which would be implied by the common law… We see no reason in law or principle for concluding that these two contractual provisions should not co-exist, and we see no justification for favouring a construction which would mean that one of these pro visions qualifies the other. In our opinion, upon a proper construction the two clauses in the first sentence of the declaration are separate and substantive. It was not disputed that if the second clause had not appeared in the first sentence of the declaration, the first clause read along with the provisions in the first part of the second sentence would amount to a warranty of the truth of the answers given to the questions in the proposal. We see no reason why the inclusion of the second clause should modify or qualify the clear warranty contained in the first clause. In the circumstances, we are satisfied on a proper construction of the declaration, that the two clauses of the first sentence are dealing with separate matters, and that there is no justification for regarding the second clause as modifying the first. We recognise that a consequence of holding that the declaration contains an express warranty of the truth of the answers to the questions in the proposal is that if there was an error in, for example, the postcode or telephone number of the proposer, the result would be that the defenders would be entitled to avoid the policy. That however is a consequence of the parties agreeing to an express warranty

with the result that the defenders would have a right to avoid the policy if an answer was untrue whether or not the untrue item was material. We are not persuaded that that would be a ludicrous result. It is simply a consequence of what parties have agreed to by contract and parties are free to agree what they like. We express no view upon the question of whether an error of this kind could be covered by the principle de minimis non curat praetor.’

[807] R A Hasson, “The ‘basis of the contract clause’ in insurance law” [1971] MLR 29 ‘No meaningful reform of insurance law can be achieved without a complete overhaul of the law which has developed around the “basis of the contract” clause in insurance litigation… The Genesis of the Clause The nineteenth century decisions are troublesome not so much for the results reached in them but rather for some overbroad statements of principle and unnecessary dicta which produced unfortunate results in later cases. Thus, in Newcastle Fire Insurance Co v Macmorran (1815) 3 Dow 255, Lord Eldon went out of his way to state, although these remarks were clearly unnecessary to the decision before him: “If the Court of Session was of opinion that the danger and risk was not greater in mills of the second class than in those of the first class though that were sworn to by five hundred witnesses, it would signify nothing. The only question is, what is the building de facto that I have insured.”

The basis of the contract clause made its first appearance in a reported case in Duckett v Williams (1834) 2 C & M 348. In that case, the trustees of the Provident Life Assurance Company had represented to the Hope Insurance Company that the “herein named John Stephenson is now in good health, and has not laboured under gout, dropsy, fits, palsy, insanity, affection of the lungs or other viscera or any other disease which tends to shorten life.” In the event of the trustees making any “untrue averment,” the Hope Insurance Company would be entitled both to avoid the policy and to retain the premiums that the Provident Insurance Company had paid. The jury found that the insured was in fact uninsurable. On these facts, Lord Lyndhurst CB rejected Provident’s argument that their duty to answer “truly” meant only that they made this statement to the best of their knowledge. In his Lordship’s view, “two consequences are to follow if the statement be untrue: one, that the premiums are to be forfeited; the other that the assurance is to be void.” This result is both defensible and rational given the fact that Duckett v Williams dealt with a reinsurance situation rather than with an original application for insurance. But the court did not make this distinction and unfortunately Lord Blackburn in Thompson v Weems (1884) 9 App Cas 671 also failed to make the distinction, treating Duckett v Williams as an authority in a case of ordinary insurance… Thompson v Weems is the last and most important of the nineteenth century decisions on the basis of the contract clause. While it is impossible to quarrel with the result, the way the result was reached seems to be open to attack. In an application for life insurance, the applicant answered the following questions as follows: “Question 7 (a) Are you temperate in your habits? (b) and have you always been strictly so? (a) ‘Temperate’ (b) ‘Yes.’” The Lord Ordinary, in a decision affirmed by a majority of the Second Division of the Court of Session found that the applicant had not made any

untrue statements in his declaration. In arguing for the reversal of this decision before the House of Lords, the Solicitor General for Scotland based his argument for overruling the decision in favour of Weems on narrow (and legitimate) grounds: “The evidence showed that Mr Weems was not in the ordinary sense of the word ‘temperate’; and more than that, he had had warnings and expostulation on the subject, which made it impossible for him to consider himself a person of temperate habits.” All would have been well if their lordships had based their decision in favour of the insurers on the ground that the applicant had acted in bad faith. Instead, Lord Blackburn went out of his way to state that “insurers have a right if they please to take a warranty against [the applicant’s]… disease, whether latent or not, and it has very long been the course of business to insert a warranty to that effect.” This practice might, no doubt, result in a “hard bargain” for the assured if he had innocently warranted what was not accurate, but if he had warranted it, “untruth” without any moral guilt, avoided the insurance.” What is also disturbing about Thompson v Weems… is that [the]…judge [did not] appreciate the proper meaning of questions relating to the applicant’s health. It would seem obvious that questions such as “Are any of your immediate family at present in a delicate state of health?” [this was question 2(b) in the proposal form] or “(1) What is the present and general state of your health? and “(2) Do you consider yourself of a sound constitution?” [this was question 4] are questions requiring only the assured’s opinion on these matters. After all, this is how such questions would be regarded by experts, ie, medical men to whom these questions were addressed. How much more so must this be the case when the addressee of these questions is a layman should have been evident to their lordships. Once the “opinion-requiring” character of these questions is perceived, the only question that remains is:

did the applicant state his honest opinion in response to the particular question? If the answer to this is in the affirmative, the insured should be entitled to recover. Twentieth Century Developments The reported cases in the present century are more unsatisfactory than those in the nineteenth century because in all too many of them, indefensible results have been reached… Dawsons v Bonnin [for the facts, see above, [805]] is undoubtedly the most important case on the subject; it is also probably the least satisfactory decision on the subject… On [the] facts, the lorry having been destroyed by a fire at the garage, the House of Lords (Viscount Finlay and Lord Wrenbury dissenting) held that the insured was not entitled to recover because of his (the insured’s) mis-statement as to where the car was to he garaged. The ways by which the majority reached this result in the teeth of the wording of provision 4 of the policy borders on the fantastic. Thus Viscount Haldane stated: “I do not look on the fourth condition appended to the policy as what is important for this purpose, for that condition extends to possible misstatements and concealments which go beyond those to which the proposal statements are confined.” This way of reading condition 4 is not supported by any further evidence or argument; it has the effect of rendering, the condition entirely redundant. Lord Dunedin reached the same result by a different route. For him, the case raised “the pure question,” as yet I think undecided, when certain statements are said to be the “basis of the contract and incorporated therewith” is that equivalent to saying that these statements are held to be “contractually material”? “Unwillingly” and “contrary to [his] first impression, his lordship decided that “it is.” It was impossible to regard the word “basis” as being “merely

pleonastic.” Thus, in order to give meaning to a single word, a whole provision, ie, condition 4, is sacrificed! It is not necessary that one be a strong supporter of the contra proferentem principle to regard this view as untenable. But even if there had been no condition 4 of the policy, it is submitted that Dawsons v Bonnin is an unfortunate decision. The misrepresentation of fact in this case worked to the benefit of the insurers, since it is less dangerous to garage a car outside Glasgow than it is to garage it in central Glasgow. On these facts, the House of Lords should have held that the insurer was not entitled to avoid the policy… The Case for Reform It seems reasonably certain that the basis of the contract clause was originally introduced into insurance policies in the early part of the nineteenth century with the purpose of drawing the attention of applicants for insurance to the fact that the information required of them was very important. The basis of the contract clause has long since served to reform this “educative” function efficiently. Today, most insureds are already aware of the need to answer questions in the proposal form with great care, since they realise that the information sought is likely to be of the greatest importance to the insurers. To the extent that some insureds still need to be educated on this point, this can be done by means other than the basis of the contract clause. It is open to insurers, for example, to point out in clear and prominent language on the proposal form that great care must be taken by the insured in supplying information; since a misstatement with respect to a material fact is liable to render the policy void. As it is, the basis of the contract clause performs little or no “educative” function and, instead, as Lord Greene MR pointed out in Zurich Insurance

Co v Morrison [1942] 1 All ER 529, it creates “traps” for the insured. There seems to be little doubt that the “trap” of the basis of the contract clause is and has been used for the most part by disreputable insurers, many of which are financially unstable. But even if it could be shown that this defence is used only by “disreputable” insurers, this would not seriously weaken the argument for legislation. As Professor Kahn-Freund has pointed out recently, in another connection: “The law, however, is concerned with the marginal cases.” The most powerful argument for maintaining the status quo is that the basis of the contract device is a necessary evil since it relieves the court from the most difficult task of determining whether a particular fact is material or not. It is easy to show that a court may be presented with some very difficult problems. Consider some examples from the law of non-disclosure: (1) Is it material that an applicant for life insurance failed to disclose the fact of previous rejections by other companies, when he had been accepted by the company to which he had submitted his most recent application? (2) Is it material that an applicant for motor insurance, was previously denied cover for fire insurance? (3) Is it material, in cases of burglary insurance that the insured had criminal convictions, fifteen or twenty years earlier ? It is true that questions like these are far from easy to resolve but it cannot be said that they are impossible to resolve. Certainly insurers cannot claim that the courts have imposed overly stringent tests in requiring proof of materiality; indeed, an argument can be made that it is, at present, too easy for insurers to establish materiality [see R

Hasson [1969] MLR 615, extracted in chapter 4]. Further, proof of materiality has not proved to be an insuperable obstacle in the United States where this task is made infinitely more difficult by the presence of the jury. The Shape of Reforming Provisions Even if the House of Lords were shortly to reverse Dawsons v Bonnin, legislation would still be essential. The following provisions are tentatively suggested. 1. No statement of the applicant should avoid the policy or be used in defence to a claim under it, unless it is contained in a written application and a copy of such application must be attached to the policy when it is delivered… 2. No oral or written misrepresentation or warranty made in the negotiation for a contract or policy of insurance by the insured or on his behalf, shall defeat or avoid the policy or prevent its attaching unless it materially affects either the acceptance of the risk or the hazard assumed by the company. The key word here is “materially.” There are three possible definitions of materiality. The first is: what might this insurer have done? The second is the New York statutory solution’s — with knowledge of the true facts, would this insurer have made this contract? The third is: if he had knowledge of the true facts, would a reasonably prudent insurer have made this contract? Choice number one need not he considered; it should be left coughing and wheezing in its stable. It is submitted that the “reasonably prudent” insurer test, although it does not force “upon the imprudent insurer the consequences of its own lax practices,” should be an adequate standard. 3. If it can be shown that the party insuring neither knew nor should have known when concluding the contract

that a statement made by him was incorrect, then such misrepresentation shall not affect the insurer’s liability. This provision will be helpful in dealing with two classes of case. The first kind of case may be illustrated by an an example: A, an applicant for life insurance, is asked if he has any brothers living. He answers “Yes,” thinking that his brother overseas is alive, whereas in fact his brother is dead. Assuming the answer is material, A should be entitled to recover [n 79 These were the facts in Globe Mutual Life Insurance Association v Wagner 188 Ill. 133, 58 NE 970 (1900]. The second class of case that this provision is intended to deal with are the “opinion” questions. Thus, B, an applicant for life insurance answers “Yes” to the question “Are you in good health?” whereas he is suffering from terminal cancer, a fact of which he is unaware. B should be entitled to recover. The above provisions represent, of course, only a first step towards the statutory control of insurance contracts. There is urgent need to give very serious consideration to the setting up of appropriate administrative machinery to police unreasonable terms in insurance contracts. At the same time, equally serious attention needs to be given to the feasibility of enacting statutory standard policies in various fields of insurance. Further consideration of these possibilities is, however, beyond the scope of this paper.’

Note: For the consumer-insured the 1986 Statement of General Insurance Practice and the Statement of Long Term Insurance Practice (binding only on members of the Association of British Insurers or Lloyd’s) have restricted the scope of the basis clause

(for a brief summary of the origins of the Statements, see chapter 4, [445]: A. Forte [1986] MLR 754). It is noteworthy that the Statements require a causal link between a breach of warranty and the loss ‘unless fraud is involved’. [808] Statements of General Insurance Practice (London, Association of British Insurers, 1986) (replacing 1977). ‘The following statement of normal insurance practice, issued by the Association of British Insurers, applies to general insurance of policyholders resident in the UK and insured in their private capacity only. 1. Proposal forms (a) The declaration at the foot of the proposal form should be restricted to completion according to the proposer’s knowledge and belief. (b) Neither the proposal form nor the policy shall contain any provision converting the statements as to past or present facts in the proposal form into warranties. But insurers may require specific warranties about matters which are material to the risk…’ 2. Claims (b) An insurer will not repudiate liability to indemnify a policyholder… (iii) on grounds of a breach of warranty or condition where the circumstances of the loss are unconnected with the breach unless fraud is involved…’

[809] Statements of Long Term Insurance Practice (London, Association of British Insurers, 1986). ‘This statement relates to long term insurance effected by individuals resident in the United Kingdom in a private capacity [emphasis added]. 1. Proposal forms (b) Neither the proposal nor the policy shall contain any provision converting the statements as to past or present fact in the proposal form into warranties except where the warranty relates to a statement of fact concerning the life to be assured under a life of another policy. Insurers may, however, require specific warranties about matters which are material to the risk. 3. Claims (a) An insurer will not unreasonably reject a claim. In particular, an insurer will not reject a claim or invalidate a policy on grounds of non-disclosure or misrepresentation of a fact unless: (i) it is a material fact; and (ii) it is a fact within the knowledge of the proposer; and (iii) it is a fact which the proposer could reasonably be expected to disclose… (b) Except where fraud is involved, an insurer will not reject a claim or invalidate a policy on grounds of a breach of a warranty unless the circumstances of the claim are connected with the breach unless: (i) the warranty relates to a statement of fact concerning the life to be assured under a life of another policy and that statement would have constituted grounds for rejection of a claim by

the insurer under 3(a) above if it had been made by the life to be assured under an own life policy; or (ii) the warranty was created in relation to specific matters material to the risk and it was drawn to the proposer’s attention at or before the making of the contract…

8.3 The Classification of Warranties Broadly speaking, warranties can be classified into three types depending on whether the undertaking relates to: (i) some past or existing state of affairs; (ii) some future state of affairs; (iii) an opinion by the insured as to the truth of a fact. A warranty within the first category, an ‘affirmative warranty’, generally arises out of the information provided in the proposal form and made the basis of the contract. If the answer or statement is false when made, the insurer is discharged from liability as from that point (in practical terms the insurer is discharged from liability as from the commencement of the contract). The accuracy of such a statement is therefore a condition precedent to the validity of the policy. But if such a statement is true when made but becomes false through a subsequent change of circumstances occurring after the contract commences, then, assuming the contract does not

place the insured under a continuing duty to notify the insurer of any changes to the risk, discharge from liability does not occur. A warranty within the second category is a ‘promissory’ or ‘continuing’ warranty (see Dawsons Ltd v Bonnin (above, [805])). Such an undertaking will stipulate that something shall be done or will exist during the currency of the policy. Its effect is to impose continuing obligations on the insured to control the risk (for example, in motor insurance, to maintain the vehicle in a roadworthy condition: Conn v Westminster Motor Insurance Association [1966] 1 Lloyd’s Rep 407). Such a warranty may be created by the proposal form which is made the basis of the contract; where this is not the case it then becomes a question of construction whether a warranty is promissory in nature. A breach of a promissory warranty (also called a condition precedent by insurers and judges alike) may discharge the insurers from liability as from the date of the insured’s breach. Finally, warranties of opinion are common in proposal forms relating to consumer insurance. The effect is to introduce a proviso into the contract that the insured merely warrants that the answers given are true to the best of his or her belief and knowledge. Such a warranty will only be broken where the insured was dishonest or reckless: see Confederation Life Assn v Miller (1887) 14 SCR 330; Huddlestone v RACV Insurance Pty Ltd [1975] VR 683; and the Law Commission Report No 104, para 6.7.

A lucid judicial formulation of the classification of insurance warranties was delivered by Chief Justice Moss in Reid v Hardware Mutual Insurance Co 252 SC 339 (1969): ‘A warranty, in the law of insurance, is a statement, description, or undertaking on the part of the insured, appearing in the policy of insurance or in another instrument properly incorporated in the policy, relating contractually to the risk insured against. Generically, warranties are either affirmative or promissory. An affirmative warranty is one which asserts the existence of a fact at the time the policy is entered into, and appears on the face of said policy, or is attached thereto and made a part thereof. A promissory warranty may be defined to be an absolute undertaking by the insured, contained in a policy or in a paper properly incorporated by reference, that certain facts or conditions pertaining to the risk shall continue, or that certain things with reference thereto shall be done or omitted…While it is generally recognised that a warranty may be “promissory” or “continuing,” the tendency is to construe a statement in the past or present tense as constituting an affirmative rather than a continuing warranty. Thus, a description of a house in a policy of insurance, as “occupied by” the insured, is a description merely and is not an agreement that the insured should continue in the occupation of it…A statement in an insurance policy that the property is occupied by the insured as a dwelling for himself and family, is not a warranty that it shall continue to be so occupied but is only a warranty of the situation at the time the insurance is effected.’

[810] Woolfall and Rimmer Ltd v Moyle [1942] 1 KB 66 (CA)

[The proposal form for employers’ liability insurance, which was incorporated into the policy by a basis of the contract clause, contained the following question: Question 2 (c) “Are your machinery, plant and ways properly fenced and guarded, and otherwise in good order and condition.” The insured answered “Yes.” While standing on scaffolding which collapsed three workmen were injured and a fourth died]. Lord Greene MR: ‘It is argued in this court, as it was argued before Asquith J, that that question means a great deal more than it professes on the face of it to ask. It is said that it does not merely relate to the moment of time at which the proposer answers it, but that it extends to the future condition of the machinery, plant and ways, during the currency of the policy. In my opinion, there is not a particle of justification for reading into that perfectly simple question any element of futurity whatsoever. The argument that the court should read into it such an element was based, as I understood it, on the suggestion that the answer would be valueless from the underwriters’ point of view unless that were done. I entirely disagree. The value of the question to the underwriters, as I construe it, is that it enables them to find out with what sort of person they are dealing, that is, whether or not he keeps his machinery, plant and ways properly fenced and guarded and otherwise in good order and condition. Obviously, if he was careless about that, so that at the time the question was answered his machinery, plant and ways were not in good order and condition, the risk would be of a different character. If the underwriters intended to refer to the future, it is most unfortunate that a printed document of this kind, tendered by Lloyd’s underwriters to persons desiring to insure with them, should

not be so expressed. Had they intended that this question should carry the meaning which they now suggest, nothing would have been easier than to say so. If they did not mean it, I am at a loss to understand how the point comes to be taken. In my judgment, the meaning of this question is perfectly clear and there is no evidence that the plank which was the cause of this accident was not in good order and condition at the time when the question was answered, or, indeed, that it was then in the possession of the plaintiffs. I should add that Asquith J. construed the words “and otherwise in good order and condition” as referring to some condition of the plant ejusdem generis with fencing and guarding, and he, accordingly, held that the question did not apply in any case to scaffolding materials such as we have to deal with here. We have not heard Mr Sellers and, accordingly, it would not be right to say more about that view of the learned judge than that it is one which, at first sight, appears to me to be difficult to support…’

[811] Hales v Reliance Fire and Accident Insurance Co [1960] 2 Lloyd’s Rep 391 [The insured, a shopkeeper selling grocery, provisions, newspapers, tobacco and confectionery, effected a policy against fire. The proposal form, which contained a basis of the contract clause, asked: “2. (b) Are any inflammable oils or goods used or kept on the premises? Answer “Lighter fuel”.

The proposal form also contained the following condition:

“8. Every Warranty to which the Policy is, or may be, made subject, shall from the time the Warranty attaches apply and continue to be in force during the whole currency of the Policy, and non-compliance with any such Warranty, whether it increases the risk or not, shall be a bar to any claim hereunder…”

Fireworks were delivered to the shop shortly before Guy Fawkes’ Day. They were stored in a cardboard box and an open tin box. The fireworks in the tin box exploded causing damage to the shop and trade property]. McNair J: ‘…I should just summarise the evidence on one material point which was relied upon strongly by the plaintiff, and that is this: that it became quite clear to me in the course of the hearing, if it had not been within my knowledge before, that a small shop such as the plaintiff’s, carrying on business described as grocery, provisions, newspapers, tobacco and confectionery is a shop where it might well be expected that at Guy Fawkes time fireworks in limited quantities would be available for sale. The evidence did not show that you would invariably find fireworks at that time in a shop of this description, but I think it fair to say that certainly there is nothing unusual in fireworks being for sale for a short period of time in such a shop, and indeed I will go further, the evidence shows that it is more than likely that in such a shop at Guy Fawkes time there would be found comparatively small quantities of fireworks for sale…The first defence is that there was an untrue answer in the proposal form… Now, on the first question, Mr Jukes, on behalf of the insurance company, puts his argument quite shortly. He says that the first question is a pure question of

construction on its application to the facts, namely, whether it is true to say, as the plaintiff has in effect said by his answer, that there were no inflammable oils or goods used or kept on the premises other than lighter fuel. Mr Jukes rightly admits that the onus of establishing that lies on the defendant company, but contends that any answer given to that question is in fact a warranty in view of the declaration at the foot of the proposal form, which I have read, and that, if it is a warranty, the materiality of the statement is irrelevant… Now, on the question of construction it is said by Mr Jukes that there are two possible points as to its application. Does it relate only to the time at which the proposal form is answered, or is the answer in the nature of a continuing warranty?… In my judgment, whatever may be the meaning of the expression “keeping inflammable oils and goods” I am quite clear that the question and the answer taken with it must be taken as a warranty both as to the existence of the fact at the time of the proposal, and during the currency of the risk. It is not necessary to rely upon Condition 8 of the policy, which I have already read, though the application of Condition 8 would produce the same result if, contrary to the view I have expressed, the question and answer themselves had not produced that result. But the critical question in the case is whether it could correctly be said that the fireworks in the quantities which I have described, brought into a shop in accordance with a usual practice, are, or can be said, to fall within the expression “inflammable oils or goods used or kept on the premises”. One approaches that problem with certain well settled principles in mind. Firstly, and mainly, that it is the duty of underwriters or insurance companies if they seek to rely upon a question in a proposal form, to state their question in clear and unambiguous terms, and I think that extends to this, they must state in such terms as can be

understood by the persons who are likely to be required to answer them, which includes persons of humble rank and perhaps not of the highest intelligence. A further principle which I think is clear is that the questions must be read in their context — which includes being read in relation to the subject-matter of the insurance — in this case a small shop carrying on a trade described as “Grocery, Provisions, Newspapers, Tobacco, Confectionery”. Applying those principles, I have to make up my mind, firstly, on the question of the meaning of the word “inflammable”. There has been no expert evidence as to the meaning of the word inflammable. Although the plaintiff himself admitted that fireworks such as he kept were clearly inflammable, I do not attach very much importance to that. I attach some importance to the fact that fireworks are quite clearly explosive within the meaning of the Explosives Act, 1875, and that there are statutory provisions which regulate the keeping of fireworks in small quantities when they are kept for sale in a shop like this, and which require that they shall be kept in some place of security and not exposed, as these fireworks were, and unprotected, to any chance contact with flame or match or anything of that kind. It seems to me that, reading this question in its context, this policy on the trading goods, which includes probably the most important item, the fire risk, that the term “inflammable” means something which increases the fire risk by reason of the fact that the goods have any inherent quality of being easily set on fire. I do not believe that anybody, if asked the simple question “Are fireworks inflammable?”, would have the slightest doubt in answering the question “Yes”, although he may have the recollection that sometimes on a wet November evening when having a firework party it is difficult to set them alight, but as a matter of ordinary common sense it seems to me quite plain that in the ordinary sense of the word fireworks are inflammable…

I have come to the conclusion, accordingly, that there was an untrue answer to Question 2. (b), that answer in effect being that no inflammable oils or goods were used or kept on the premises, except lighter fuel, the fact being that, for a period round Guy Fawkes’ Day, substantial quantities of fireworks, which in my judgment were inflammable, were kept. That is sufficient to dispose of this action…’

Note: The decision in Hales is questionable in the light of more recent decisions that evidence a marked reluctance on the part of the judiciary towards finding a warranty to be promissory in nature (see, inter alia, Hair v Prudential Assurance Co Ltd [1983] 2 Lloyd’s Rep 667; Hussein v Brown (below, [812]); Kennedy v Smith and Ansvar Insurance Co Ltd (below, [813]); and Kler Knitwear Ltd v Lombard General Insurance Co Ltd (below, [818]). [812] Hussein v Brown [1996] 1 Lloyd’s Rep 627 (CA) [The insured effected a fire policy in respect of his commercial premises. Question 9 of the proposal form asked: “Are the premises fitted with any system of intruder alarm? If YES give name of installing company. (Please provide a copy alarm specification if applicable).”

The insured answered ‘Yes’ and ‘See specification’. The proposal form contained a basis of the contract clause.

A fire occurred at the insured premises at a time when the alarm system was inoperative. The insurers contended that the answer given to question 9 in the proposal form constituted a continuing warranty that the premises were fitted with an intruder alarm, that the alarm was operational and/or would be habitually set by the plaintiff when the premises were unattended and that, therefore, the insured’s breach of warranty discharged them from liability]. Saville LJ: ‘In my judgment, despite these authorities [including, inter alia, the decision in Hales]…there is no special principle of insurance law requiring answers in proposal forms to be read, prima facie or otherwise, as importing promises as to the future. Whether or not they do depends upon ordinary rules of construction, namely consideration of the words the parties have used in the light of the context in which they have used them and (where the words admit of more than one meaning) selection of that meaning which seems most closely to correspond with the presumed intentions of the parties… In these circumstances, despite the respect one always has for judgments of McNair J, I agree with Judge Kershaw that the persuasive strength of the Hales’ decision is reduced. Indeed, as I have indicated, if and to the extent that it suggests that there is any special principle applicable to proposals for insurance in general, or fire insurance in particular, I consider it to be wrong… In the present case, the question posed for the potential insured was in the present tense. In addition, it did not seek on its face any information as to the practice of the proposer with regard to the alarm, for example, whether it was set when the premises were left unoccupied. The construction contended for by Mr Brodie [for the insurers] involves not

only reading the present tense as referring to the future, but also as importing into the question an inquiry whether the alarm would be kept operational, and/or (to use the words in Mr Brodie’s skeleton argument) “habitually set by the Plaintiff” when the premises were left unattended. I can see nothing in the words of the simple question posed, or to be gleaned from the context, which begins to suggest that what an affirmative answer entails is an undertaking as to the future along these lines. Mr Brodie sought support for his construction by suggesting that to confine the question to the state of affairs existing when it was answered, would be of no assistance to underwriters and would therefore be absurd, so that to give any sense it must have been intended to refer to the future. I disagree. In the first place, it seems to me that the argument assumes that the answer to the question would be “yes”. If the answer was “no”, then even Mr Brodie, it seemed, tended to shrink from the proposition that if the insured later fitted an alarm he would be in breach of warranty and the cover would cease, for this would indeed represent a real absurdity. It follows from this that the meaning of the question, on Mr Brodie’s construction, differs depending on the answer that is given. To my mind, this is a quite untenable proposition. In the second place, it is, in my view, of value to underwriters to know whether or not an alarm is fitted, for depending on the answer, underwriters could require one to be fitted, or indeed seek a continuing warranty or decline the risk. In the third place, it must be remembered that a continuing warranty is a draconian term. As I have noted, the breach of such a warranty produces an automatic cancellation of the cover, and the fact that a loss may have no connection at all with that breach is simply irrelevant. In my view, if underwriters want such protection, then it is up

to them to stipulate for it in clear terms. A good example of the way this can be done is in fact to be found in the standard printed terms incorporated into the certificate itself when dealing with theft risks, though, of course, these are not directly relevant to the insurance under discussion which was limited to fire risks. The fact that such a warranty would be likely to give underwriters more protection than a warranty as to the existing state of affairs is not in itself a reason for construing a question which on its face is only directed to that state of affairs, as importing warranties as to the future… As I indicated at the beginning of this judgment, one of the arguments raised in the notice of appeal and developed before Judge Kershaw in the Court below, was that condition 5 [which required the insured to give notice of any alteration likely to increase the risk of loss] amounted to what was described as a “condition subsequent to liability” any breach of which entitled underwriters to cancel the cover, and the argument was that, since the insured in the present case had not given the due notice under condition 5 when the position regarding the alarm was changed, that itself, by virtue of that condition, entitled the underwriters to repudiate the contract with effect from the date of the breach. This afternoon, however, Mr Brodie tells us that he accepts that that argument cannot really be pursued. I respectfully agree with him. I can find nothing in the language of condition 5, or in the insurance as a whole, which lends any support to such an argument. On its face the object of condition 5 was to enable underwriters to obtain a further reasonable premium if the risk increased. Without condition 5, underwriters are bound to the cover, even if the risk does increase. With condition 5 they are still bound, but are entitled to an additional reasonable premium to reflect the increased risk. If the assured fails to give due notice, it seems to me that all that has happened, as far as condition 5 itself is concerned, is that underwriters have in

practical terms been deprived, until the breach is discovered, of their right to more premium. Under condition 5 they have not been deprived of any right to bring the cover to an end, for no such right is granted by condition 5…’

[813] Kennedy v Smith and Ansvar Insurance Co Ltd 1976 SLT 110 (First Div) [The insured, the defender, completed a proposal form for car insurance in which he signed an ‘Abstinence and Membership Declaration’ and warranted that he was ‘a total abstainer from alcolholic drinks and have been since birth.’Above his signature in the proposal form was a statement that he had withheld no relevant information and that the warranty given should be held to be promissory and should be, with the abstinence and membership declaration, the basis of the contract between him and the insurance company. The policy which was issued contained the following exceptions: “5 (a) Any claim arising while the insured or any other person otherwise indemnified under this Policy is under the influence of intoxicating liquor. 5 (b) Any claim arising while the insured vehicle is being driven by…(i) the insured having consumed intoxicating liquor prior thereto in breach of the abstinence declaration.”

Condition 7 of the policy provided: “The due observance and fulfilment of the terms provisions conditions and endorsements of this Policy

in so far as they relate to anything to be done or complied with by the Insured and the truth of the statements and answers in the said proposal shall be conditions precedent to any liability of the Company to make any payment under this Policy.”

After a bowling match the insured left with two friends in his car to drive home. During the journey they stopped at a pub where he had a pint, at most a pint and a half of lager. He had eaten little food during the day. Shortly after leaving the pub the insured was involved in an accident and his two passengers were killed. The families of the two deceased passengers sued the insured and he called the insurance company as third party. The insured admitted liability and the amount of damages in each case was agreed. The underwriters refused to indemnify the insured on the basis that at the time of the accident his statement that he had been a total abstainer from birth was untrue, and that when the claim arose he was under the influence of intoxicating liquor]. The Lord President (Emslie): ‘…For the defenders, the submission was that statement 2 [the abstinence declaration] is no more than a warranty of the defender’s position at the time of the proposal and since birth, and there is nothing in the policy itself to cast doubt upon this construction. This is clear from the tenses used and it would have been easy if the third party had intended it to contain a promise for the future to have said so in clear and simple terms. Support for that submission was, it was argued, to be found in the obligation to advise the company if the information given in the form “ceases to apply”, and in

condition 3 of the policy, just as in policy no 12 of process, the third party is empowered to cancel the policy. These features point against reading statement 2 as an undertaking that the insured will not cease to be a total abstainer during the currency of the insurance… Although in the course of the hearing counsel for the parties referred us to a number of cases in which construction of particular statements or answers in proposal forms was in issue, I do not find reference to these to be helpful. What I do find helpful, however, is to remind myself of the approach which the court ought to take to construction of statements, like statement 2, incorporated in proposal forms and the like…[the Lord President reviewed, inter alia, the judgments in Provincial Insurance Co v Morgan (above, [803]) and Woolfall & Rimmer v Mole (above, [810])]…There are, of course, many more [authorities] but I content myself now by saying that if insurers seek to limit their liability under a policy by relying upon an alleged undertaking as to the future prepared by them and accepted by the insured, the language they use must be such that the terms of the alleged undertaking and its scope are clearly and unambiguously expressed or plainly implied and that any such alleged undertaking will be construed, in dubio, contra proferentem. In my opinion, approaching the question of construction in this case as it must be approached, I am, with respect to the Lord Ordinary, quite unable to construe statement 2 as he has done…The statement does not require to be given a future promissory content to make it intelligible. It is quite intelligible if it is read literally for no doubt the risk during the period of insurance is reduced if at the outset the proposer is a total abstainer since it may reasonably be hoped that he is unlikely to abandon his principles. It would have been simple to include in the statement if this had been intended, that the insured shall continue to be a total abstainer for the period of the insurance. No such statement

was, however, included and in my opinion is not, without undue straining of the language used, to be implied. The undertaking above the defender’s signature is more consistent with the literal construction which I favour than with any other, and in short I am quite unable to read statement 2 as an undertaking not to drink in the future when this could so readily have been said and was not… If I am right so far, then the only remaining matter to be resolved is whether, under either policy, condition 7 precludes any liability on the part of the third party. Upon this branch of the case, the main argument in support of the Lord Ordinary’s decision was that the declaration contained the promissory undertaking not to drink during the currency of the insurance. This argument is the same as was advanced in connection with exception 5 (b) (i), and I reject it for the reasons which I have already given… The subsidiary argument was this. Before the third party’s liability to meet a claim can arise the insured must show that all conditions precedent to liability have been satisfied, and all conditions precedent must be satisfied by the time a claim arises. In this case the defender had not, by the time the claim of the pursuers arose, complied with the undertaking at the end of the abstinence declaration. It was of no consequence that it was not in fact possible for the defender to advise the third party before the accident for this is an impossibility the defender created for himself. In my opinion this argument is unsound. As matter of construction the undertaking falls to be read as an undertaking to advise the third party within a reasonable time after the information in statement 2 ceased to apply. It is not contended that a reasonable time had elapsed before the accident and the defender had not therefore failed to comply with a condition precedent by the time the claims arose. If the [insurers]…had intended to require the defender to advise them before any claim arose or to refrain from driving until after he had done so they could readily

and simply have said so. They did not do so expressly or by plain implication and I am not prepared to construe condition 7 and the undertaking in the way we have been invited by the third party to do…’

Lord Avonside: ‘…The true question is whether the terms of the declaration are to be construed against the insured in such a manner that a lapse by him leads immediately to contravention of the declaration. In my opinion it does not. It has been said time and again that if insurers wish to lay down a condition which can be expressed clearly and simply then they must do so. I content myself by referring as an example to what was said by the Master of the Rolls in Woolfall & Rimmer v Mole. In the present case the declaration by the appellant clearly refers to his position at its date and previously. The passage quoted above is a definition and the words “never drinks” cannot be taken out of context to imply any undertaking as to future conduct. Finally, the undertaking by the appellant to advise the respondents if the information given by him ceases to apply shows clearly, to my mind, that the respondents had within contemplation the possibility of an insured person ceasing to be a total abstainer, required notification thereof and on receiving such notification would no doubt consider whether or not to continue affording insurance. If the respondents had wished to make future abstinence a feature of the declaration of total abstinence they could easily have done so. That was not done and futurity cannot be brought in by any attempt to raise some kind of implication…’

[814] John Birds, “Warranties in Insurance Proposal Forms” [1977] JBL 231

‘Among the many problems which may face insured persons in understanding the full range of their rights and duties under their insurance policies are the full meaning and consequences of the questions, answers and declarations in the proposal form. Normally only filled in at the very inception of the insurance, its contents often, one suspects forgotten, nevertheless the slightest inaccuracy in it may debar a claim on the policy many years later. Generally inaccuracies will relate to incorrect answers to specific questions, but proposal forms often also contain declarations, eg of the value of insured property. If the form contains the appropriate phraseology (normally a “basis of the contract” clause) and is incorporated into the subsequent policy, such declarations as well as the questions and answers are capable of amounting to warranties — exact truth is then a condition precedent to the validity of the policy. Unfortunately insurers do not always draft these clauses as clearly as they might, nor do they make it entirely clear to the layman exactly what are the consequences of even the slightest inaccuracy… The different types of warranty It seems appropriate first to review briefly the legal status of the different answers and statements to be found. (1) The most straightforward example is the question and answer which, taken together, clearly warrant the truth of particular facts at the date the proposal form is completed. The classic example is the leading case of Dawsons Ltd. v Bonnin [above, [805]] where the immaterial inaccuracy as to where the insured lorry was garaged was held by the House of Lords to entitle the insurer to avoid the policy ab initio. (2) Insurers can make statements as to future facts or future states of affairs into warranties, ie a warranty that a certain state of facts will or will not exist at

some time in the future or will or will not continue to exist for the future. The best description of this type of warranty is perhaps a continuing warranty. The effect of a breach would seem to be that the insurer can avoid the policy from the date of breach. (3) Something which may be very difficult to distinguish from the continuing warranty is the clause in the proposal form which is merely “descriptive of the risk,” sometimes, rather unfortunately, referred to as a warranty describing the risk. Such a clause is held to describe those times, and those times only, when the insurer will be at risk. A breach will not avoid the policy, but merely relieve the insurer from liability if the clause is not being complied with at the time of loss. The best known case on this is Farr v Motor Traders’ Mutual Ins Soc Ltd [below, [816]]…The Court of Appeal held that the insurer could not avoid the policy. As a matter of construction, the clause was not a warranty that each cab would only ever be used in one shift per day. Presumably, had the question and answer been as follows: “Will each vehicle always be driven solely in one shift per 24 hours? Yes,” the result would have been different… Suggestions for reform However, this raises the question as to how far insurers should he allowed to create continuing warranties. Even if the language is clear, there may be warranties of a totally immaterial character, though in both Kennedy [see Kennedy v Smith, above, [813]] and Hales [see Hales v Reliance Fire and Accident Insurance Co, above, [811]], they were clearly very relevant to the risk and there seem to he sound reasons for permitting abstinence declarations (to use the Kennedy example); presumably people insured under those terms pay less. But however material the warranty, do many insured persons realise the obligations they may be under?

They do not generally see the proposal form after it has been filled in at the inception of the insurance. In Kennedy, the insured signed that declaration 10 years before the accident and he may well have reasonably forgotten about it. True, in law the contents of the proposal form are invariably incorporated into the policy which contains the terms of the generally annually renewed contract. But it is difficult enough to understand and remember all the matters in the policy itself, regardless of those in the once seen proposal form. It is submitted that legislative action is desirable to mitigate this harshness, in addition to the Law Reform Committee recommendations [see below, [830]]…Insurers should be obliged specifically to incorporate in the policy those questions and answers and declarations intended to be continuing warranties. Further, there should be a clear statement in bold type or differently coloured ink emphasising the effects of a breach of warranty. And it might also be useful to require insurers, when sending out renewal notices or accepting renewal premiums, to stress in writing to the insured the continuing importance of these warranties as well as the other terms and conditions of the insurance policy…’

Notes: 1. It has already been seen that the terms of the typical insurance contract may be incorporated from a number of different documents. It should also be noted that the typical insurance policy is increasing in complexity in order to meet the requirements of a sophisticated commercial marketplace. It is now common for a policy document to be subdivided into separate sections, each section containing its

own terms (including warranties), which deal with the different risks to be covered. 2. The question that arises in this situation is whether the terms contained in one section will necessarily be read as applying to the contract as a whole so that a breach of warranty contained in one section will automatically discharge the insurer from liability where the occurrence of a particular risk is covered by another section of the policy not reproducing the warranty in question. If the policy is read as a whole the insurer will be discharged. But, if it is possible to sever the particular section as to which the claim is made from the remainder, the insurer’s liability will not be discharged. The issue recently came before the Court of Appeal. [815] Printpak v AGF Insurance Ltd [1999] Lloyd’s Rep IR 542 (CA) [The insured, a print finishing business in Leeds, effected a “commercial inclusive policy” which contained a number of sections each covering different risks. Section A of the policy covered the insured’s stock and other goods against damage by fire. Shortly after the insurance commenced the insured claimed for fire damage. The defendants repudiated liability on the basis of, inter alia, breach of warranty. By warranty number P17 (contained in Section B which covered theft) the insured had warranted that a burglar alarm had been installed on the premises which was fully operational when they

were closed to business and which would be maintained under contract by an alarm company throughout the currency of the policy. At the time of the fire the alarm had been switched off during building work. The insurers contended that Section A of the policy was not confined to any specific kind of cover and that warranty P17 in Section B applied to the whole policy]. Hirst LJ: ‘The point we have to decide here is one of construction, namely whether P17 warranty covers each and every section of the policy or only the theft section into which it is incorporated. We are not concerned with its effect if once it was established that it has such a very wide ambit. In my judgment, it does not follow from the fact that the policy is a single contract that it is to be treated as a seamless contractual instrument. On the contrary, in the present case, its whole structure is based on its division into sections. It was up to the assured to decide which sections he wished to adopt in his particular case as the ones that would be covered by the policy. The commercial inclusive endorsements are all stated in terms to be “operative only as stated in the policy schedules”. In my judgment, those words explicitly write the warranty into the relevant section in which it appears and not into the others, as is also borne out by the heading “section endorsements” below which P17 actually comes into the schedule under theft. This is the only reference in the policy schedule to P17, and, as a result, the policy is, in the words of section 33 [of the Marine Insurance Act 1906] subject to an express condition, so that P17 will only be operative in relation to a claim under Section B, theft, which it is noteworthy specifically excludes loss or damage caused by fire or explosion…’

8.4 Terms Descriptive of Risk: Suspensive Conditions As noted by Professor Birds (above, [814]), terms that describe or limit the risk (exceptions) merely suspend the insurer’s liability during the period in which the insured is in breach. However, as with warranties or conditions precedent, the insurer is not required to establish a causal link between the insured’s non-compliance and the loss. But once the insured resumes compliance with such a term, the insurer will again be on risk (see the reasoning of Lord Russell in Provincial Insurance v Morgan (above, [803]). [816] Farr v Motor Traders Mutual Insurance Society Ltd [1920] 3 KB 669 (CA) [The facts appear from the judgment of Bankes LJ]. Bankes LJ: ‘The question in this appeal relates to the construction of a contract of insurance into which the parties have entered. The assured answered certain questions in a proposal form, and those questions and the answers thereto were made the basis of the contract and were incorporated therein. The only question for decision by the learned judge, and by us, is whether the answer to one of the questions constitutes a warranty by the assured. If, as a matter of construction, it can properly be held that the question and answer amount to a warranty, then, however absurd it may appear, the

parties have made a bargain to that effect, and if the warranty is broken, the policy comes to an end… In this case the question which we have to decide is whether the particular statement in the proposal form is a definition of the risk or a warranty…In the present case the proposal form contains the following: “Is the vehicle driven solely by the proposer?” — “No.” “If not, state whether driven in one or more shifts per 24 hours.” — “Just one.” That was a true statement at the time it was made, and it remained a true description of the risk down to August. In that month one of the two taxi-cabs which the assured owned required some repairs, and it was sent away for that purpose. When it was away the assured gave the driver of that cab permission to take out the other cab, as the assured said, in order to earn a few shillings. As a consequence that taxi-cab was for a day or a little longer driven in more than one shift each 24 hours; but apparently that took place for a very short time. Then the practice of driving these two cabs separately by separate drivers in one shift per day each was resumed, and continued down to and including the date when the second accident happened. The question is whether we are to construe the question and answer, as the defendants contend, as a warranty, the effect of which would be that in August, when the cab was driven in two shifts per day, the policy came to an end; or whether we are to construe them, as Rowlatt J has construed them, as words descriptive of the risk, indicating that whilst the cab is driven in one shift per 24 hours the risk will be covered, but that if in any one day of 24 hours the cab is driven in more than one shift, the risk will no longer be covered and will cease to attach until the owner resumes the practice of driving the cab in one shift only. In my opinion, having regard to the nature of the question, it is impossible to construe the answer thereto as a warranty.’

[817] CTN Cash and Carry Ltd v General Accident Fire and Life Assurance Corporation plc [1989] 1 Lloyd’s Rep 299 [The insured’s cash and carry business premises were insured with the defendants. The policy contained 12 sections including burglary insurance and money insurance. Shortly after a theft involving an assault on the insured’s staff the insurers surveyed all of the insured’s depots and it was agreed that the burglary and money insurances were to be subject to the following term: “It is warranted that the secure cash kiosk shall be attended and locked at all times during business hours.”

Thereafter, the insured instructed staff that someone was to be in the kiosk at all times. In November 1986 there was a robbery at one of the insured’s depots in Burnley. While the business doors to the warehouse were still open, the insured’s employee [F] decided to get the till key from the office which was above the kiosk in order to cash up. As she descended the stairs to return to the kiosk which she had locked, a person enquired as to the price of some whisky. F and another employee, N, having investigated the price were returning when N was assaulted by masked men and forced to the ground and F was tied up and her keys taken. The thieves escaped with goods valued at over £100,000. The insured’s claim under the policy was repudiated by the insurers on the basis that the

insured was in breach of the obligation to keep the kiosk attended at all times during business hours]. Macpherson J: ‘I have to look at all the facts in order to decide the first important question which arises, which is this: what was the nature of the new term, which was stated to be a “warranty” but which is not, in my judgment, magically clothed by having that label attached to it from its early days? The issue is this: was it a condition entitling the insurers to repudiate the contract of insurance for its breach or was it a clause delimiting the risk in this particular area? In the end, I have no doubt but that it was a risk delimiting clause. First, that is my strong impression and conclusion upon the facts relating to its inception. Secondly, in my judgment, the cases cited to me tip the balance even further down in favour of the defendants’ arguments. The fact that there were 12 sections to the policy is strongly relevant. This clause could only be relevant to the two sections with which we are concerned, and it is presumably for that reason that the whole of the policy and the remaining sections have never been put before me. It would be unrealistic, in my judgment, to imagine a breach of this warranty bearing in any way upon the rest of the sections of the policy, to which I have not been referred…It seems to me that, although the word “warranty” is attached to this clause, it is a risk delimiting clause dealing with these specific circumstances discussed by both parties beforehand and imposed in the manner in which I have described. The importance of the identity of the legal nature of the clause is this: if [counsel] is right and the warranty is a condition of the policy, then it would have been necessary for the insurance company to have repudiated at once upon realising that there had been a breach of the term because breach of an insurance warranty which is a contractual

condition entitles them so to repudiate; and if they do not repudiate timeously, then they are held to have waived the breach and could only sue in damages for breach of the term as if it was an ordinary contractual warranty and not a condition. I have, as I say, firmly reached the conclusion that this is a risk delimiting clause, both by way of impression and by way of identification as assisted by the authorities to which I have referred. I turn then to the clause itself. Two points arise: first, was the kiosk attended; and, secondly, was this robbery in business hours? As to the first of those questions, I have no doubt whatsoever…it seems to me that I have to conclude that permanent presence, apart from the momentary turnover at times when that had to take place, was required by the clause… Mr Rowe [counsel for the insured] argued that the words were apt to mean “In the near vicinity of”, indicating that if a person who was normally in the box remained in its near vicinity it could be argued that the box was still attended. Interpreting the words and looking at the birth of the clause, I am unable to accept that contention. Secondly…I must look at the question of whether this robbery took place in business hours. In the end, I am sure that it did and that a jury of reasonable men on the Burnley omnibus would so have concluded. Anybody standing in the car park and seeing the doors stood open, the notices indicating that the shopping hours ended at 8 p.m., the lights still on, the kiosk occupied except for the visit of [F] to get the key but returning in order to cash up, would, as a matter of pure common sense, in my judgment, conclude that business hours were still in operation. The trolleys were outside, the shelves were illuminated and fully available to customers, and, as I have said, [F] was only out of her box in order to get the key so as to cash up while the doors were

still open so that the doors could be closed punctually at 8 p.m. and so that she and [N] could then depart… I am convinced that this robbery took place in business hours. That again is partly a matter of impression and commonsense, and I am, unfortunately for the insured, driven to the firm conclusion that that was so… Therefore, in my judgment, this robbery took place when the kiosk was not attended and it took place during business hours. In those circumstances, since causation does not arise with respect to a risk delimiting clause, the insurers are entitled to succeed… Therefore, upon all his arguments helpfully and completely put as they were by [counsel], the plaintiffs fail, and I have, with a measure of reluctance but in the end without any doubt, to accept that there was no cover in this case at the relevant time and that the plaintiffs’ claim is unsuccessful. There must, therefore, be judgment for the defendants.’

[818] Kler Knitwear Ltd v Lombard General Insurance Co Ltd [2000] Lloyd’s Rep IR 47 [The insured, a hosiery and knitwear company with premises in Leicester, effected a policy with the defendants which contained, inter alia, the following sprinkler installations warranty: “It is warranted that within 30 days of renewal 1998 the sprinkler installations at the Jellicoe Rd/Gough Rd/Spalding Rd locations must be inspected by a LPC approved sprinkler engineer with all necessary rectification work commissioned within 14 days of the inspection report being received.”

The sprinkler installations were not inspected within the required 30 days of renewal but rather about 60

days after. The insured premises at Jellicoe Road were damaged by a storm and the claimant sought to recover under the policy for his losses arising from damage to raw materials and finished goods and from disruption of the business. The insurers rejected the claim on the basis that the sprinkler inspection clause is a true contractual warranty]. Morland J: ‘At the hearing of this appeal…argument was confined to two questions. 1. On a proper construction of the Clause within the context of the policy is the clause a warranty or a suspensive condition? 2. Is there in reality a triable factual issue as to whether or not Mr Wright inspected the Claimants sprinkler system at 46 Jellicoe Road on 25 August 1998? I shall answer the construction question first. I shall begin by setting out the principles and guidelines upon which I must approach the question of construction. My task is to ascertain the intention of the parties. That intention is to be derived from the clause in the context of the policy as a whole set against its contractual matrix. That matrix was that on the other side a manufacturing company was seeking in short all risks cover in respect of its commercial premises and on the other side an insurance company was offering such cover through a policy with its endorsements the language of which was of its own authorship. If, on a proper construction of a clause, the intention of the parties was that the clause should be a warranty, the Court must uphold that intention by giving effect to the

warranty however harsh and unfair the consequences to the insured may be. It is wholly irrelevant to the question of construction that as in this case the insureds loss had no causative link with his breach of obligation. Presumably the primary purpose of the clause was to reduce the risk of losses from fire. A possible secondary purpose was to reduce the risk of water damage due to malfunction of the sprinkler system. If the clause is a warranty, and the policy spells out that a claim is barred, it matters not that storm damage rather than fire or malfunction of the sprinkler system caused the loss. The fact that the clause is entitled warranty and contains the phrase it is warranted is some indication that the parties intended that the clause be a warranty in the true sense of the word. Such words are frequently used in insurance policies and used in a wide variety of senses. A warranty in a proposal form that statements of existing facts are true and accurate is a world apart from a warranty which in effect is a promise as to future conduct. The former is clearly crucial to the assessment of risk and the level of premium. The latter too may affect the assessment of risk and the level of premium because a proposed insured who is willing to give an obligation as to his future conduct may be giving an indication of his reliability and business efficiency. Still unbroken or unfulfilled promises as to the future conduct as opposed to the future existence of a state of affairs are of a very different character to breaches of warranties as to existing facts… Mr Edelman QC for the defendant submitted that these cases [inter alia, Farr v Motor Traders Mutual (above, [816]); Roberts v Anglo-Saxon Insurance (above, [802]); and CTN v General Accident (above, [817])] were all distinguishable because the obligation which was broken related to compliance on a routine or repeated basis whereas the obligation in the clause in question was to do a specified single act within a specified time. It was a once and for all

obligation. However, Mr Edelman was unable to refer me to any authority which suggested that a clause continuing a once and for all obligation is indicative of a warranty rather than a suspensive condition. Mr Edelman also relied heavily upon the General Conditions: — “GENERAL CONDITIONS 1. This Insurance Policy and Schedule of Cover together with any Endorsements shall be read together as one contract and any word or expression to which a specific meaning has been attached in any part shall bear such specific meaning wherever it may appear. 2. The following General Conditions apply to the whole Insurance except where otherwise specifically stated in individual Section(s) WARRANTIES: every Warranty to which this Insurance or any Section thereof is or may be made subject shall from the time the Warranty attaches apply and continue to be in force during the whole currency of this Insurance and non-compliance with any such Warranty; whether it increases the risk or not, or whether it be material or not to a claim, shall be a bar to any claim in respect of such property or item, provided that whenever this Insurance is renewed a claim in respect of Damage occurring during the renewal period shall not be barred by reason of a Warranty not having been complied with at any time before the commencement of such period.” Mr Edelman submitted that the Farr line of cases had no such condition relating to warranties. The condition states that non-compliance with a warranty bars a claim as opposed to entitling the insurer to avoid under the policy.

However as Mr McLaren for the claimant pointed out this condition only spells out the consequences of noncompliance with a warranty. It begs the question whether a clause is a warranty or a suspensive condition. Moreover in the definition of pages of the policy there is no definition of warranty. Mr McLaren drew my attention to the similar wording in both the Waste Warranty and the sprinkler installation Warranty. It would be utterly absurd and make no rational business sense whatever if at the end of a particular working day a small quantity of sawdust was not swept up and 300 days later a fire broke out due to an electrical fault that a claim for property damage would be barred; similarly if inspection of the sprinkler system was not carried out on time. Although it is wholly irrelevant on the matter of construction, in fact the inspection was said to be out of time because parts of the sprinkler system were in units not in the claimants control and there were difficulties in gaining access. I have come to the clear and unhesitating conclusion that the clause is a suspensive condition and not a warranty. In reaching that conclusion I derive comfort from the words of Saville LJ in Hussain v Brown [above, [812]]…at p. 630: — “In the third place, it must be remembered that a continuing warranty is a draconian term. As I have noted, the breach of such a warranty produces an automatic cancellation of the cover, and the fact that a loss may have no connection at all with that breach is simply irrelevant. In my view, if underwriters want such protection, then it is up to them to stipulate for it in clear terms. A good example of the way this can be done is in fact to be found in the standard printed terms incorporated into the certificate itself when dealing with theft risks, though, of course, these are not directly relevant to the insurance under discussion which was limited to fire risks. The fact that such a warranty would

be likely to give underwrites more protection than a warranty as to the existing state of affairs is not in itself a reason for construing a question which on its face is only directed to that state of affairs, as importing warranties as to the future.” I therefore find in favour of the Claimant on the first question as I also do on the second question…’

Notes: The Court of Appeal in Virk v Gan Life Holdings plc [2000] Lloyd’s Rep IR 159 again stressed that in general the determination of the nature of a particular clause is an exercise requiring the language of the policy document to be construed as a whole irrespective of any label applied to a particular term by the parties. But if ‘care and logic’ has been taken in the choice of such a label, that is likely to be decisive. Potter LJ stated: ‘In relation to the exercise of construction to be undertaken by the court, the question of “labelling” is influential rather than decisive, particularly if the label “condition precedent” has been applied to a number of terms of differing type and practical importance. On the other hand, if care and logic appear to have been applied in the attachment of the label to one term but not to another, the label (or absence of it) is likely to be decisive… Whatever presumption may arise in a case where the parties have attached the label “condition precedent” to a contractual term or terms, it is plainly the position, as stated in Stoneham v Ocean Railway and General Accident Insurance Co (1887) 19 QB 237 at 239, that:

“…where the question is left at large, it is for the Court to say, looking at all the terms of the policy, what the true meaning of the contract is (per Mathew J).” Indeed, in the ultimate analysis that is so in all cases. Wherever doubt arises as to the meaning and effect of a term in its immediate context, the court will consider the wider context and commercial purpose of the condition, however it is labelled. Where, as in this case, there is no label attached to any of the terms in the insurance contract, the question of the effect of any individual term and, in particular, when the cause of action under the policy first accrues, is an open exercise in construction unconstrained by considerations peculiar to insurance contracts, save for the broad distinction to which I have already referred between liability and other types of insurance. The heart of the matter lies in ascertaining from the terms of the particular contract the event or events upon which the right to claim indemnity is conditioned….’

8.5 Consequences of Breach of Warranty In the general law of contract a breach of condition entitles the innocent party to elect to repudiate the contract. Until recently, it was thought that this was the case in insurance law. However, in The Good Luck (below, [819]) the House of Lords held that the immediate effect of a breach of a promissory warranty is to automatically discharge the insurer from liability as from the date of the breach. [819] Bank of Nova Scotia v Hellenic Mutual War Risks Association (Bermuda) Ltd, The

Good Luck [1992] 1 AC 233 (HL) [The facts are immaterial]. Lord Goff: ‘We are here concerned with the nature of warranties in contracts of marine insurance. We have to distinguish between two forms of warranty, viz, those warranties which simply denote the scope of the cover…and those which are promissory warranties, involving a promise by the assured that the warranty will be fulfilled. It is with the latter type of warranty, which is the subject of section 33 to 41 of the Act of 1906, that we are concerned in the present case. Since the Act is a codifying Act, which provides in section 33 for the nature of a promissory warranty and in section 34 for the circumstances in which a breach of such a warranty may be excused, it is appropriate to start our inquiry with those sections… So it is laid down in section 33(3) that, subject to any express provision in the policy, the insurer is discharged from liability as from the date of the breach of warranty. Those words are clear. They show that discharge of the insurer from liability is automatic and is not dependent upon any decision by the insurer to treat the contract or the insurance as at an end; though, under section 33(3), the insurer may waive the breach of warranty… …[I]t becomes readily understandable that, if a promissory warranty is not complied with, the insurer is discharged from liability as from the date of the breach of warranty, for the simple reason that fulfilment of the warranty is a condition precedent to the liability of the insurer. This moreover reflects the fact that the rationale of warranties in insurance law is that the insurer only accepts the risk provided that the warranty is fulfilled. This is entirely understandable; and it follows that the immediate effect of a breach of a promissory warranty is to discharge

the insurer from liability as from the date of the breach. In the case of conditions precedent, the word “condition” is being used in its classical sense in English law, under which the coming into existence of (for example) an obligation, or the duty or further duty to perform an obligation, is dependent upon the fulfilment of the specified condition. Here, where we are concerned with a promissory warranty, ie a promissory condition precedent, contained in an existing contract of insurance, non-fulfilment of the condition does not prevent the contract from coming into existence. What it does (as section 33(3) makes plain) is to discharge the insurer from liability as from the date of the breach. Certainly, it does not have the effect of avoiding the contract ab initio. Nor, strictly speaking, does it have the effect of bringing the contract to an end. It is possible that there may be obligations of the assured under the contract which will survive the discharge of the insurer from liability, as for example a continuing liability to pay a premium. Even if in the result no further obligations rest on either party, it is not correct to speak of the contract being avoided; and it is, strictly speaking, more accurate to keep to the carefully chosen words in section 33(3) of the Act, rather than to speak of the contract being brought to an end, though that may be the practical effect. When, as section 34(3) contemplates, the insurer waives a breach of a promissory warranty, the effect is that, to the extent of the waiver, the insurer cannot rely upon the breach as having discharged him from liability. This is a very different thing from saying that discharge of the insurer from liability is dependent upon a decision by the insurer. As Kerr LJ said in State Trading Corporation of India Ltd v M Golodetz Ltd [1989] 2 Lloyd’s Rep 277, 287, after referring to the decision of the Court of Appeal [1988] 1 QB 818 in the present case: “Thus, the correct analysis of a breach of warranty in an insurance contract may be that, upon the true construction

of the contract, the consequence of the breach is that the cover ceases to be applicable unless the insurer subsequently affirms the contract, rather than to treat the occurrence as a breach of the contract by the insured which the insurer subsequently accepts as a wrongful repudiation.” It was no doubt because of the decision of the Court of Appeal in the present case that Kerr LJ expressed himself in tentative terms. But I respectfully agree with his basic approach, as I do with the approach of Hobhouse J, which is entirely consistent with the plain meaning of section 33(3) of the Act of 1906. I cannot help feeling that the Court of Appeal in the present case were to some extent led astray by passages in certain books and other texts which refer to the insurer being entitled to avoid the policy of insurance, or to repudiate, when the assured has committed a breach of a promissory warranty. Such language is, I have to say with all respect, inappropriate in this context. I imagine that it reflects the fact that, faced with such a breach, the insurer can decide, if he wishes, to waive it. But, as I have said, the insurer does not avoid the policy. Moreover it is only in the sense of repudiating liability (and not of repudiating the policy) that it would be right to describe him as being entitled to repudiate. In truth the insurer, as the Act provides, is simply discharged from liability as from the date of the breach, with the effect that thereupon he has a good defence to a claim by the assured…’

Notes: 1. See J Birds [1991] LQR 540; and H Bennett [1991] JBL 592 2. While strictly speaking The Good Luck is a marine insurance authority, the principle of

automatic cessation has been held to apply to a non-marine policy: ‘[T]he moment that [breach of warranty] occurred the insurance cover was automatically discharged without any action or election by the insurer (or reinsurer)…’ HIH Casualty and General Insurance Ltd v AXA Corporate Solutions [2002] Lloyd’s Rep IR 325, per Jules Sher QC (for the decision of the Court of Appeal see [820], below).

8.5.1 Breach of Warranty: Waiver vs Estoppel An important issue that arises in the context of warranties is whether insurers can waive a breach. Although section 34(3) of the Marine Insurance Act 1906 provides that a breach of warranty may be waived, the Court of Appeal held in HIH Casualty and General Insurance Ltd (below, [820]) that waiver has an extremely limited application. This, it is suggested, must be right because it necessarily follows from the decision in The Good Luck that since breach of warranty automatically discharges the insurer’s liability, the language of election in the context of waiver is no longer appropriate: there is no election to make. However, scope does remain for the doctrine of estoppel to prevent insurers from insisting on their strict legal rights.

[820] HIH Casualty and General Insurance Ltd v AXA Corporate Solutions [2003] Lloyd’s Rep IR 1 (CA) [The issues appear from Tuckey LJ’s judgment]. Tuckey LJ: ‘…In short the dispute is between a reinsured (HIH) and its 80 per cent quota share reinsurers (which include Axa) in respect of pecuniary loss indemnity insurance written by HIH to cover loss by the financiers of two slates of films. HIH have paid their insured over $31 million in settlement of their claims under this insurance but the reinsurers say that HIH were not liable and they are not liable under the reinsurance. One of the defences raised by the reinsurers was that both the insurance and the reinsurance contained warranties as to the number of films which would be made: 6 in the 7.23 slate and 10 in the Rojak slate. This was disputed by HIH and on their initiative was the first of the preliminary issues ordered to be tried. This court decided the 6 film (or 10 film) slate terms were terms of both insurance and reinsurance contracts and were warranties. In fact by the expiry of the policy periods (22 July 1999 for 7.23 and 8 November 1999 for Rojak) only 5 and 7 films respectively were made. It followed that HIH and their insured were in breach of warranty. Following the decision of the House of Lords in The Good Luck… it is now clear that insurance law treats such a warranty as a condition precedent to liability under the contract so from the moment of breach there is no cover for the risk insured. However, a breach of warranty may be waived and by amendments to its pleadings made after the order had been made for trial of preliminary issues HIH contended that Axa had done so in this case. Axa maintained that HIH’s claim formulated in this way had no real prospect of success and

so applied for it to be dismissed summarily under CPR 24.2(1)(a)(i). This application succeeded before Jules Sher QC sitting as a Deputy High Court Judge and HIH now appeal from his decision with the permission of Rix LJ. Similar applications by the other reinsurers await the outcome of this appeal. HIH contend that the judge misdirected himself on the issue of waiver and that there was another compelling reason for a trial… The relevant facts HIH’s amended pleadings alleged simply that from September 1998 in the case of 7.23 and January 1999 in the case of Rojak Axa had received monthly risk management reports which made it clear that the warranted number of films had not been and would not be made and yet it raised no objection until service of its defences in June 2000 when breach of warranty was first alleged. The pleading went on to say that HIH had relied on this conduct because if Axa had raised objections about the number of films the parties would have resolved those objections by agreement, failing which HIH would have pursued the same objections with their insured or denied liability under the original insurances. The legal consequences of these facts were pleaded in various ways including waiver by estoppel. Having referred to the risk management reports and some of Axa’s comments on them the judge concluded: “So Axa knew in the case of Rojak at least by February 1999 that it was not intended to produce more than 8 films and in the case of 7.23 Axa knew that only 5 films were actually being produced at all material times.” Later in the judgment he said: “The evidence before me comes from the solicitors on each side. There is no evidence from the representatives of HIH

and Axa who were involved at the relevant times. Despite this it is quite apparent from the correspondence between the parties that neither side realised that the failure to produce 6 films in the 7.23 slate and 10 in the Rojak slate might have the consequence that cover was wholly and automatically discharged on the grounds of breach of warranty. That realisation came, it seems at or about the time of the defences…The important point to make however is that HIH do not assert that Axa (or indeed HIH themselves) were aware that the reinsurance (and insurance cover) had (or even might have) been discharged as a result of breach of warranty in relation to the number of films produced in each slate. That realisation, as I say, came much later…” The Judgment In dealing with the law the judge started by recognising that where there is a breach of warranty there is no scope for traditional waiver by election because the insurer is automatically discharged from liability upon breach and therefore has no choice to make. This is why only waiver by estoppel availed HIH, if it did…He then said: “Waiver by estoppel or promissory estoppel, as it is more commonly described, involves a clear and unequivocal representation that the reinsurer (or insurer) will not stand on its right to treat the cover as having been discharged on which the [reinsured] (or insured) has relied in circumstances in which it would be inequitable to allow the reinsurer (or insurer) to resile from its representation. In my judgment it is of the essence of this plea that the representation must go to the willingness of the representor to forego its rights. If all that appears to the representee is that the representor believes that the cover continues in place, without the slightest indication that the representor is aware that it could take the point that cover had been

discharged (but was not going to take the point) there would be no inequity in permitting the representor to stand on its rights. Otherwise rights would be lost in total ignorance that they ever existed and, more to the point, the representee would be in a position to deny the representor those rights in circumstances in which it never had any inkling that the representor was prepared to waive those rights. It is of the essence of the doctrine of promissory estoppel that one side is reasonably seen by the other to be foregoing its rights.” …The judge recognised by reference to The Superhulls Cover Case (No 2) [1990] 2 Lloyd’s Rep 431, 450 that a party can represent that he will not enforce a specific legal right by words or conduct. “He can say so expressly.…Alternatively he can adopt a course of conduct which is inconsistent with the exercise of that right. Such a course of conduct will only constitute a representation that he will not exercise the right if the circumstances are such as to suggest either that he was aware of the right when he embarked on the course of conduct inconsistent with it or that he was content to abandon any rights that he might enjoy which were inconsistent with that course of conduct.” The judge records Mr Flaux QC, for HIH then as now, as submitting that it was only necessary to show that Axa were aware of the relevant facts which constituted the breach of warranty. It was not necessary to show that Axa knew as a matter of law that these facts constituted a breach of warranty. In support of this proposition Mr Flaux had cited the well-known passage from Lord Goff’s judgment in The Kanchenjunga [1990] Lloyd’s Rep 391, 399 in which he contrasted waiver by election and waiver by estoppel. The relevant part of this passage says:

…equitable estoppel requires an unequivocal representation by one party that he will not insist upon his legal rights against the other party, and such reliance by the representee as will render it inequitable for the representor to go back upon its representation. No question arises of any particular knowledge on the part of the representor, and the estoppel may be suspensory only. Furthermore the representation itself is different in character in the two cases. The party making his election is communicating his choice whether or not to exercise the right which has become available to him. The party to an equitable estoppel is representing that he will not in future enforce his legal rights. His representation is therefore in the nature of a promise which though unsupported by consideration, can have legal consequences; hence it is sometimes referred to as promissory estoppel. In rejecting Mr Flaux’s submission the judge said: “It appears to me that all Lord Goff is doing in the sentence underlined is emphasising that in the case of equitable estoppel what matters is how the representation appears to the representee, as opposed to election where the concentration is upon the knowledge of the representor. It is plain from the passage cited from Lord Goff that the representation in the case of equitable estoppel, must be that the representor will not insist upon his legal rights against the other party. It seems to me that this sentence makes it clear that the representation must be that the representor is prepared to forego his legal rights. This is particularly so when this language is compared with Lord Goff’s reference a few lines before to the case of election in which the representor has to make an informed choice made with knowledge of the facts giving rise to the rights. At any rate, in my judgment, Mr Flaux can gain no comfort

from the passage he cited from Lord Goff’s speech in The Kanchenjunga.” The judge thought that this conclusion probably made it unnecessary to consider other issues between the parties but he went on to find firstly that Axa’s conduct did not amount to an unequivocal representation that it would not enforce its rights. He accepted the submission by Mr Hamblen QC for Axa that silence could only amount to a representation where there was a duty to speak. Next, the judge found that the reliance pleaded by HIH was not what was required. What was required was: “that HIH relied upon a representation by Axa that it would not enforce its right to treat the cover as discharged”. and there was no evidence of such reliance… The Appeal It is common ground that in order to establish waiver by estoppel HIH had to show: (a) a clear and unequivocal representation by Axa that it would not insist on its right to treat the reinsurance cover as discharged because of the reduction in the number of films which were made; and (b) such reliance by HIH on this representation as to make it inequitable for Axa to go back on it. HIH also had to establish that it had similarly waived the breach of warranty by its insured, but the judge did not make any express finding about this and although this point is the subject of a respondents notice, I do not think it is necessary to consider it further for the purpose of deciding this appeal. Mr Flaux submits that the judge effectively held that you could not have an estoppel of this kind unless the

representor knew, not only the relevant facts, but also what his legal rights arising from those facts were. This, he submits, led the judge wrongly to conclude that Axa had not made the required representation because it had not made a representation that it was prepared to forego its legal rights and that HIH’s reliance was not of the kind required because it had not relied on any such representation. Knowledge by Axa or HIH that the reduction in the number of films was a breach of warranty was not required. Axa’s representation was to be implied from their conduct in continuing to act as if they were on risk after they knew of the reduction in the number of films. The only right which this reduction gave Axa was to treat the cover as discharged. By continuing to treat it as on foot without protest or reservation of rights Axa acted inconsistently with this right, alternatively any right which it might have had as a result of the reduction. In these circumstances the representation made by Axa was clear and unequivocal and was not derived only from silence or failure to take the point because Axa continued to be actively involved in this cover after they knew of the reduction. There is no dispute between the parties about the relevance of knowledge to waiver by estoppel and there was apparently no such dispute before the judge. Mr Hamblen QC for Axa does not and did not submit that the representor has to have knowledge of the legal right upon which he will not insist. This is clear from the passages in The Kanchenjunga and Superhulls cited by the judge. Mr Hamblen submits however that the representation must carry with it some apparent awareness of the right upon which the representor will not insist. Mr Flaux did not dispute this and I do not think he could have done so because otherwise the representation would lack the necessary character to found the estoppel. As the judge put it “the essence of the plea must go to the willingness of the representor to forego its rights”. Unless the representation

carries with it some apparent awareness of rights it goes nowhere: the representee will not understand the representation to mean that the representor is not going to insist upon his rights because he has said or done nothing to suggest that he has any. What I have said illustrates the difficulty in establishing this type of estoppel when neither party is aware of the right which is to be foregone. A representor who is unaware that he has rights is unlikely to make a representation which carries with it some apparent awareness that he has rights. Conversely a representee who is not aware that the representor has a particular right is unlikely to understand the representation to mean that the representor is not going to insist on that right or abandon any rights he might have unless he expressly says so. It follows I think that knowledge, or rather lack of it in this case is important when one comes to consider whether the estoppel has been established. Nothing in the authorities or the texts to which we have been referred casts doubt on this conclusion. But did the judge go wrong on the question of knowledge? I do not think so. He does not say that to found the estoppel Axa needed to know what their legal rights were. In the second passage which I have quoted [above] he makes it clear that it is not Axa’s knowledge which is important but how their conduct appeared to HIH. I agree. His comment on The Kanchenjungathat “the representation must be that the representor is prepared to forego his legal rights” simply follows what Lord Goff says. The judge is not saying that the representor must know what those legal rights are. Following the passage from Superhulls which I have quoted, Mr Flaux developed his case on representation by saying that Axa had adopted a course of conduct which was inconsistent with its right to treat the cover as discharged in circumstances which suggested that it was content to

abandon any rights which it might enjoy as a result of the reduction in the number of films. I cannot accept this argument. Axa’s conduct is best characterised as silence or inactivity, not in the face of a claim but in the context of a continuing contractual relationship where on the information before us it is not possible to say precisely when the breaches of warranty actually occurred. As Chitty (para 3-087) says: “Although a promise or representation may be made by conduct, mere inactivity will not normally suffice for the present purpose since it is difficult to imagine how silence and inaction can be anything but equivocal. Unless the law took this view mere failure to assert a contractual right could lead to its loss; and the courts have on a number of occasions rejected this clearly undesirable conclusion.” The only exception to this rule is where the law imposes a duty to speak or act, but no such duty is alleged here. The fact that Axa called for risk management reports says nothing about their reaction to the information in those reports about the reduction in the number of films. It is not alleged that M Guillot discussed the reduction in the number of films with Mr Forrest and in any event there is no suggestion that anything M Guillot may have said was or was to be passed on to HIH. Conduct from which it might be inferred that Axa thought they were still on risk does not of itself amount to a representation that they would not enforce a right or rights. None of the cases go this far. So I think the judge was right to conclude that Axa did not make a clear and unequivocal representation of the kind required to found the waiver alleged. I also think that the judge was right about reliance. It was not enough to say that if Axa had taken the point earlier HIH would have been able to do something about it. Some more positive act of reliance was required. HIH needed to show

that they had attached some significance to the representation alleged and acted on it. Not surprisingly there was no evidence to this effect. As Clarke, the Law of Insurance Contracts says at (para 20–7C): “if the insured believes that the insurer is unaware of his breach of warranty, he will find it not entirely impossible but certainly rather difficult to convince the court that he justifiably relied on the insurer’s not pleading a breach, of which the insurer was unaware…The more so if the insured is also unaware of his breach.” …In reaching the conclusions which I have I have borne in mind that this case was decided summarily against HIH. The question therefore is whether they have a real prospect of successfully overcoming the fact that on this court’s construction of the reinsurance contract they were in breach of warranty. I agree with the judge that they do not. I do so reluctantly because this means they are left at least without being able to recover Axa’s proportion of the reinsurance of this risk after paying out in full on the insurance… For these reasons I would dismiss this appeal.’

[821] John Birds, “Insurance Contracts” in J Birds, R Bradgate and C Villiers (eds), Termination of Contracts (Chichester, Wiley Chancery, 1995) ‘…The effect of a breach of warranty Perhaps the most interesting questions concerning termination of insurance contracts arise where the term in question is a warranty. This is principally because of the relatively recent leading case, namely the decision of the House of Lords in Bank of Nova Scotia v Hellenic Mutual War

Risks Association (Bermuda) Ltd, The Good Luck [see above [819]]. In this case it was held that a breach of warranty in a marine insurance contract automatically discharged the insurer from liability, in accordance with the literal meaning of the words in section 33(3) of MIA 1906… The decision warrants detailed attention before we turn later to the question of its applicability outside marine insurance. An insured shipowner had clearly acted in breach of warranty by taking the ship into an area which the insurers had declared to be prohibited. The benefit of the insurance had been assigned to a bank which had lent money to the insured and was a mortgagee of the ship. The insurers, who had been notified of the assignment, gave an undertaking to advise the bank promptly “if the ship ceases to be insured”. Notwithstanding this, the insurers failed to advise the bank until some weeks after it had discovered the breach of warranty and the loss of the ship. During this period, the bank decided to make a further advance to the insured, which, it was held, it would not have done had the insurers complied with the undertaking to advise it promptly. Restoring the judgment at first instance and reversing the Court of Appeal ([1990] QB 818), the House of Lords upheld the bank’s claim for damages on the basis that the club had acted in breach of the undertaking. The insurance ceased automatically, pursuant to section 33(3) of MIA 1906, when the warranty was broken. In the Court of Appeal the issue had been approached from the point of view of general contract and non-marine insurance law; the construction of the relevant provision of MIA 1906 had been relegated to secondary consideration. The judges there reasoned that in non-marine insurance it was settled that the effect of a breach of warranty was like that of a breach of condition in general contract law, and were concerned to ensure that marine insurance adopted the same view. Lord Goff of Chievely, giving the only

reasoned speech in the House of Lords, was totally dismissive of non-marine sources as aids to construction of a codifying statute whose language was, in his opinion, clear. He was clear that the Court of Appeal had confused the distinction between conditions as fundamental terms of a contract and conditions precedent. “Section 33(3) of the 1906 Act reflects what has been described, in successive editions of Chalmers’ The Marine Insurance Act 1906, as the inveterate practice in marine insurance of using the term ‘warranty’ as signifying a condition precedent…Once this is appreciated, it becomes readily understandable that, if a promissory warranty is not complied with, the insurer is discharged from liability as from the date of the breach of warranty, for the simple reason that fulfilment of the warranty is a condition precedent to the liability or further liability of the insurer. This moreover reflects the fact that the rationale of warranties in insurance law is that the insurer only accepts the risk provided that the warranty is fulfilled. This is entirely understandable; and it follows that the immediate effect of a breach of a promissory warranty is to discharge the insurer from liability as from the date of the breach. In the case of conditions precedent, the word ‘condition’ is being used in its classical sense in English law, under which the coming into existence of (for example) an obligation, or the duty or further duty to perform an obligation, is dependent upon the fulfilment of the specified condition. Here, where we are concerned with a promissory warranty, ie a promissory condition precedent, contained in an existing contract of insurance, non-fulfilment of the condition does not prevent the contract from coming into existence. What it does (as s 33(3) makes plain) is to discharge the insurer from liability as from the date of the breach.” ([1992] 1 AC 233 at 262–3.)

The reasoning here is clearly logical. It cannot be denied that the decision of the House of Lords is in accordance with the literal meaning of section 33(3) of MIA 1906. It makes the warranty more like an exception to the risk than a contractual condition as traditionally described, since the operation of an exception is in no way dependent upon a decision of the insurer. It may be, however, that the decision that, in effect, the insurer is discharged from performance on a breach of a warranty, in fact equates with the effect of a breach of condition in the sale of goods sense…The insurance contract may survive a breach of warranty in the sense of there being obligations of the insured which may survive the breach, for example to pay a premium, although, in the opinion of Lord Goff, this is likely to be a rare occurrence and in practice the contract will come to an end, unless there is waiver of the breach as discussed below. The language of repudiation is inappropriate, as Lord Goff points out, at least in terms of repudiating or avoiding the policy. “[I]t is only in the sense of repudiating liability… that it would be right to describe [the insurer] as being entitled to repudiate.” If The Good Luck applies to nonmarine insurance contracts, a point which is discussed further below, it explains cases where rights of the insurer, as well as obligations of the insured, have been held to survive a breach of warranty. An example comes from the cases which have upheld a term forfeiting the premium paid, notwithstanding that the breach of warranty was one which has conventionally been regarded as destroying the contract ab initio. If the contract survives the breach, but the insurer is discharged from its obligation to perform, then a forfeiture clause must be enforceable. However, there are some difficulties with the decision. One arises out of section 34(2) of MIA 1906 which provides that where a warranty has been broken, the assured cannot avail himself of the defence that the breach has been remedied, and the warranty complied with, before loss.

While no doubt correct and expressing the result of decided cases, this section now appears to be a somewhat redundant provision. More difficult is the thorny question of waiver by the insurer of a breach of warranty. The Act states that a breach of warranty can be waived (s 34(3)), and some such concept seems essential in the sense that there will be many occasions where an insurer is, in fact, content to overlook a breach of warranty. It may overlook it completely in the sense of paying a claim in full or it may use the breach in negotiating for a settlement lower than the insured’s actual loss. However, the concept of “waiver” seems difficult to understand in the face of what looks like some sort of automatic termination of a contract, or at least of the cover provided under the contract. Perhaps waiver here should be read as referring to a sort of reinstatement. Alternatively, the decision may mean that the insurer is discharged from liability unless it expressly chooses otherwise. This is the converse situation to that faced by an innocent party to other contracts where there has been a fundamental breach by the other party; here the innocent party must make a conscious election whether or not to treat the contract as repudiated. If this analysis is right, the question could arise as to whether the insurer has the right to insist on waiver or “reinstatement”, in a case where the insured might be quite content for the insurer to be discharged from liability… …[A]s already mentioned, it has been conventional in respect of non-marine contracts to treat a warranty as a fundamental term of the contract, breach of which entitled the insurer to repudiate the contract in its entirety, a view with some support from case-law, and strongly argued by the Court of Appeal in The Good Luck. In other words, a warranty in insurance had the same legal effect as, it has conventionally been thought, a condition in other contracts, especially those for the sale of goods. However, this view must now be regarded as highly suspect in law at the very

least. Indeed, while Lord Goff in The Good Luck was primarily concerned to construe the marine insurance provisions, much of what he said, including in the passage cited above, was not so confined, and it may be that similar principles apply in respect of contracts of sale in any event… If this view is right, the authorities which have assumed that, in a non-marine context, the effect of a breach of warranty is to give the insurer the right to repudiate the policy must be regarded as wrong. The most difficult to reconcile with The Good Luck is the decision in West v National Motor and Accident Insurance Union [1954] Lloyd’s Rep 461. Here, the insured was alleged to be in breach of a warranty as to the value of property insured. The insurers purported to reject his claim while relying upon a term of the policy to enforce arbitration. It was held that by relying on the term, the insurers had waived their right to avoid the policy which was the only right they had. The decision has been criticised as inconsistent with general contractual principle, since it is accepted that an arbitration clause survives a fundamental breach of contract; but, in fact, if The Good Luck is applicable to non-marine policies, it must also be wrong as inconsistent with insurance principles. If the insured’s breach simply discharged the insurers from liability, but did not necessarily affect the contract as a whole, the reliance on an arbitration clause by itself could not have been a waiver. It was concern to escape the consequences of the West decision which led the insurers to argue, in another recent case, that a term which they had drafted as a warranty and inserted on renewal in order to minimise the risk they were exposed to, was not in fact a warranty in the strict sense but rather a clause or statement descriptive of the risk. In CTN Cash & Carry Ltd v General Accident Fire & Life Assurance Corp plc on renewal of a general commercial policy insuring the plaintiffs cash and carry business, the insurers inserted

a term under which the insured “warranted” that certain anti-theft, security measures would be complied with. It was held that this was a clause descriptive of the risk and not a warranty in the strict sense. A warranty in the strict sense is only a clause which goes “to the root of the transaction between the parties which ought to avoid or relieve the [insurers] from their liability under the policy”. Here, the “warranty” could relate only to two sections of a policy which was a general commercial policy with 12 sections in total. While the result of this case seems sensible, the reasoning which construed the term as merely descriptive of the risk does appear somewhat out of line with some of the leading cases on warranties, particularly on proposal form warranties, where insignificant or immaterial breaches entitled the insurers to be completely discharged. Furthermore, the device in this case was used for the benefit of the insurers, who had drafted the term using the term “warranted”, and not to protect the insured, as in the earlier leading cases on clauses descriptive of the risk. The reason for the insurers’ successful argument was that they did not wish their liability under the whole contract to be discharged, because they wanted simply to repudiate a claim. It was thought that they could not do this by alleging a breach of warranty in the strict sense, because of the decision in West v National Motor and Acccident Insurance Union Ltd (above). However, if, as has been suggested, The Good Luck applies to non-marine contracts, the decision in West is wrong. Insurers in the situation exemplified by the Cash & Carry case, which is likely to be a uncommon situation in practice, could perhaps argue that they are discharged from liability by reason of the breach of warranty and repudiate the claim accordingly, but otherwise the contract can still stand. It must be said, however, that the House of Lords in The Good Luck assumed that the whole contract would, in practice, come to an end so far as the

insurers’ liabilities were concerned, even if it might survive in terms such as the insured’s continuing liability to pay a premium. Perhaps this is where the straightforward application of The Good Luck to non-marine insurance contracts falls down. There is a much greater variety of types of term and drafting in non-marine contracts as opposed to marine contracts. The sometimes confusing categorisations which have been considered here — warranties, conditions, conditions precedent, clauses descriptive of the risk, etc — do not seem to have their counterpart in marine insurance. What is clearly now needed, outside some well-thoughtthrough statutory guidelines, is a decision which properly considers the effect of The Good Luck and the variety of insurance terms in a non-marine context. It is suggested that it would be quite proper to apply that case to the true non-marine insurance warranty, but that it must be recognised that the possibility for the insurer to elect for the contract to continue after a breach is a real one and, indeed, from the insured’s point of view, an important one, especially in situations of multi-section insurance policies. This can be called waiver of breach, but, with respect, it would be better if language were used which more accurately reflected the actual choices involved. It is also necessary to determine exactly what the insurer must or must not do to confirm the choice. It is thought that an additional consequence of applying The Good Luck to non-marine situations would be a more logical structure to insurance law, and, it may be hoped, more sensible policy wordings. Insurers would be able safely to use the warranty for the risk-related term and there is a greater chance that insurance consumers would understand the obligations imposed upon them. Conclusion

In conclusion, it must be said that the concept of the termination of insurance contracts is strictly confined to relatively few situations. So far as the insurer is concerned, in practice it will have an express right to terminate in the sense of cancelling the contract, probably for no cause. The exercise of this right will depend entirely on commercial considerations such as the claims record and behaviour of the insured. Otherwise, it will have the right to avoid the contract if the insured fails to display the utmost good faith or is guilty of non-disclosure or misrepresentation of material facts, and what is, in effect, the right to be discharged from liability (ie from performance of its obligation), for breach of warranty, unless it chooses otherwise…’

8.6 Conditions It is common for policies to contain so-called conditions precedent to recovery or liability which, by their nature, must be strictly observed by the insured: ‘the question of whether or not a particular term or requirement in an insurance policy is a condition precedent to the liability of the insurer usually arises in the context of clauses in the insurance contract governing claims procedure and, in particular, the form and time within which notice of loss must be given, the particulars and mode of proof of loss required, and arbitration clauses. Generally, the onus of proving breach of a procedural condition is upon the insurer unless it is clear from the contract of insurance that performance is a condition precedent to any claim by the insured’: Potter LJ in Virk v Gan Life Holdings plc [above]

In general, breach of such a condition precedent will entitle the insurer to avoid liability for the particular claim, not the contract as a whole, unless, of course, the policy contains a clause converting all such conditions into ‘conditions precedent to any liability of the company to make any payment’: Cox v Orion Insurance Co [1982] RTR 1 (in effect, therefore, declaring all conditions to be fundamental terms of the policy (warranties)). However, a term may be construed as a condition precedent to all future liability:

[822] Kazakstan Wool Processors (Europe) Ltd v Nederlandsche Credietverzekering Maatschappij NV [2000] Lloyd’s Rep IR 371 (CA) [The insured, KWP, processed wool at a plant in Kazakstan for export and effected credit insurance with the defendant insurerers. Article 13 of the policy provided that ‘Due payment of all premiums (and other charges) specified in Schedule 1, and the due performance and observance of every stipulation in the policy or the proposal, shall be a condition precedent to any liability on our part. In the event of any breach of any condition precedent we also have the right to retain any premium paid and give written notice terminating the policy and all liability under it.’ Premiums were calculated by reference to monthly returns submitted by the insured in respect of the amounts and value of the wool exported. If in any given month no sales were made the insured was required to submit a nil return. A claim was met by the insurers but soon after the KWP failed to submit a return for June 1998. In fact the KWP had ceased trading in May 1998 and failed to make further premium payments. Just before the policy expired in August KWP submitted further claims. The insurers gave notice of termination under Article 13 on the ground of the insured’s breaches of conditions precedent. They denied liability for any claims relating to business for which the insured was in compliance with the policy and requested the return of the earlier payment. KWP argued, inter alia,

that it was unreasonable to construe Article 13 as permitting the insurers to retrospectively avoid liability in respect of risks that had attached prior to the breaches of the policy]. Waller LJ: ‘The judge numbered the two sentences separately for convenience 1 and 2, and it is convenient to refer to them in the way that the judge did as 13(1) and 13(2), but it must be remembered that they are not so divided in the policy. The question in broad terms is whether NCM are entitled retroactively to cancel cover in respect of goods despatched prior to May 1998 for which they had received and accepted both the applicable declaration and the premium. NCMs case on construction of Article 13 is that (1) the failure to make a nil declaration and/or the failure to pay premium are conditions precedent to any liability on their part, and that includes liability on contracts other than those in relation to which the failure was relevant; and (2) that such a breach of a condition precedent also gave them the right to retain any premium paid and to give notice terminating the policy and all liability under it. On NCMs construction, not only are they entitled to defeat the claims of which notice of loss has been given but not paid, in addition they can obtain repayment of a claim already paid. KWP argue that Article 13 must be more narrowly construed. They suggest Article 13(1) suspends NCMs liability where there has been a failure to pay premium or render due performance and observe a stipulation in the policy or the proposal in so far as the failure relates to the particular contract in relation to which KWP were making a claim. Before the judge KWP contended that Article 13(2) was expressly limited to Article 13(1) by the word also. Their submission thus was that the proper construction of the two sentences read together was that Article 13(1) having

automatically suspended liability in respect of the goods to which the assureds default related, Article 13(2) gave underwriters in addition the option to terminate only the same liability which had been suspended under the first sentence — namely a liability in respect of the goods to which the assureds default related. The judge accepted KWPs construction of Article 13(1) but he did not accept their submission as to the proper construction of Article 13(2)… The facts of this case would demonstrate that NCMs construction of Article 13 is not an attractive one. It follows from their construction that if NCM foresaw six or seven claims in the pipeline likely to lead to serious losses as the six month period ran out, they can serve a notice of termination by reference to a minor breach of a stipulation in relation to some totally unconnected contract. Mr Spearman QC [counsel for NCM] recognised the onerous nature of the clause on the facts of this case but submitted that the words of Article 13 were clear and it is for that reason he submitted that the judge was wrong in his construction of Article 13 and should have gone further than he did and allowed NCM to have repayment of a claim that they had already made… Article 13(1) It seems to me clear that the construction placed on the first sentence of Article 13 by NCM must be rejected. The reasons given by the judge are, as it seems to me, compelling. First, as the judge said, if NCM are correct in their construction, they are under no liability to pay any claim until after the expiry of the policy period and after full compliance with the insured of all that may be required of it. Mr Spearman sought to argue that it was not intended that NCM would not pay before the end of the contract period;

their submission was that payment would be made during the currency of the contract but a breach of a condition precedent after payment would entitle NCM to return of their money. That, as it seems to me, would not give the normal meaning to condition precedent and does not seem to me to be an answer to what prima facie would result from a natural meaning being given to those words. Secondly, the judge refers to the draconian effect of a failure to comply with Article 4(d). That Article provides that NCM shall not be liable where (KWP) have not complied with the terms and conditions of the credit limit, or where (KWP) has not established a credit limit before the date of ascertainment of loss. The judge pointed out that on NCMs interpretation of Article 13, in addition to not being liable in relation to the particular contract, NCM would have the right to terminate under Article 13. Mr Spearmans answer as per paragraph 16.2 of his skeleton is that it might be possible to read Article 4 (where the effect of a failure is expressly spelled out) as a situation to which Article 13(1) did not apply. Whether that is so or not, as Mr Mildon [counsel for KWP] pointed out, there are numerous other conditions breach of which would have the same draconian effect. For example if there has been a failure under Article 7(A), to give notice of an overdue payment from a buyer, that too could be relied on by NCM on their argument not only as an answer in relation to the particular contract under consideration but also as suspensive of the liability to meet any other claim… In any event there is no doubt that it is the unreasonable results which the construction proposed by NCM would produce that persuaded the judge that if there was a different tenable construction that should be preferred. In my view the construction adopted by the judge, and as submitted by KWP, is the correct construction of the first sentence.

Article 13(2) Before the judge as already indicated Mr Mildon was arguing for what became his secondary position before us. He was suggesting that the first sentence of Article 13 was suspensive and that thus the link between that sentence and the second sentence should drive the court to construe terminating the policy and all liability under it as terminating the particular liability in relation to which there had been a breach of condition precedent. The suggested benefit to NCM on that construction of the second sentence was to allow them to terminate liability where there had been a breach without leaving KWP an opportunity of remedying the breach. I, like the judge, cannot accept that construction. The benefit to NCM is somewhat nebulous, since in most instances the breach of the condition precedent would have involved a failure to do something within a timescale, which would of its nature not be remediable. In addition, the words termination of the policy are difficult to read simply as termination of the particular liability in relation to which a condition precedent had been breached. Mr Mildon’s primary argument before us, he frankly accepted, was not put to the judge. It seems that the judge raised the question whether there was not some position between the views being contended for by the two sides. Clearly some argument was addressed to the judges suggestion but perhaps not formulated with any precision. The judge ultimately preferred a construction which was less extreme than that which was being contended for by NCM, but felt driven to a result which he clearly did not feel was satisfactory, but was not that being put forward by KWP. He put the matter this way: — “I do not accept that a notice under article 13(2) is intended to operate as the equivalent of an avoidance ab initio, so as

to relieve the insurers retrospectively of actual liabilities which they have already incurred and entitle them to a refund of monies paid in respect of such liabilities. If the draftsman had intended a notice of termination to have retrospective effect of that kind, he ought to have said so in plain English… As to contingent liabilities, I see fully the force of Mr Mildons argument that it would be very unattractive that an insurer, given early notification (to which he would be entitled under Article 7A) of an event likely to cause a very large loss, could avoid liability for it by serving a notice of termination based on some minor and unrelated failure to comply with the far reaching stipulations of the policy. Nevertheless, I am driven to the conclusion as inescapable that where the insurers serve a notice terminating the policy and all liability under it before the occurrence of the event which would otherwise give rise to a right of indemnity under article 1 (in this case, buyers default after 6 months), the subsequent occurrence of such event cannot give rise to liability on the part of the insurers under the policy. Although there is a difference between termination and retrospective avoidance, the effect of termination of the policy thereafter on the accrual of any liability is total. In summary, the effect of a notice of termination under Article 13(2) in my judgment is not to extinguish liabilities which have already been incurred by either party, but is to prevent any further liability arising under the policy.” In his primary argument before us Mr Mildon drew attention to certain features, as he would suggest, of the second sentence of Article 13 which were as follows: — a. It applies to liabilities of the assured as well as underwriters: ie., termination is mutual b. It permits underwriters to retain any premium already paid

c. It refers to the termination of the policy d. It is linked back into Article 13(1) by the word also and by the repetition of condition precedent. …Mr Mildon thus submitted that it must be contemplated that albeit the policy is to be terminated, some liabilities among what might at first sight appear amongst all liability will not be terminated. He submitted thus that former liabilities which have crystallised into payments are not terminated so as to bring into being an obligation to return claims paid. He would thus submit that the extreme position contended for by NCM should be rejected, as it was by the judge. He would thus further submit that if liabilities of both NCM and KWP are to be terminated it cannot have been intended to terminate KWPs obligations to assist in recovery, and make repayment under Articles 7B–G. He would submit that present liabilities that have already accrued in the sense that they have arisen out of the performance by one side or the other of its obligations are not liabilities as that word is used in the second sentence. Liability he would suggest is not intended to encompass any more than what the parties would expect from a termination of the policy, as opposed to a termination of the cover already provided. Mr Spearman submitted that what the second sentence entitles NCM to do on its plain words is to serve a notice terminating the policy when there has been a breach of any condition precedent to any liability. The sentence further provides that all liability will be terminated. He thus further submitted that if the claims of which notice has been given are only payable once the six month period has expired, and if the period has not expired as at the date of the notice, the notice must terminate NCMs liability to pay. He accepted that as the facts of this particular case show even on the judges construction, the provision can be viewed as extremely beneficial to the insurer, enabling the

insurer to pick a minor breach of condition on some contract quite unrelated to the claims that have been notified and are about to crystallise, and bring to an end all obligations to pay the substantial claims. But he says the insured should have appreciated that fact. He suggests that it is extremely uneconomic for insurers to have to chase up insurers for minor sums and that a provision as draconian as this one is necessary to keep insureds in line.

Conclusion It seems to me that NCMs construction of the second sentence produces such an unreasonable result that if a more palatable construction is tenable that has to be preferred. It is unlikely in the extreme that the parties, if they applied their mind to Article 13, would have contemplated that a minor breach of a stipulation in the eleventh month of the policy would entitle NCM to bring the contract to an end, retain all the premium, not pay the claims in relation to which it was simply the six month period which had yet to expire, and (on NCMs most extreme case) be repaid the claims already paid. Furthermore, it cannot seriously be suggested that it is necessary to have such a draconian provision in the policy in order to keep insureds in line. If the meaning of the second sentence were as suggested by NCM, there would seem to be no need for the first sentence. That sentence, and many of the other provisions, would have to be construed as simply providing for a fall back position in case the extreme position was waived by NCM. It is clear to me, and I agree with the judge, that the most extreme position contended for by NCM can be rejected. On any view the second sentence was not intended to relieve NCM from a liability already incurred, so as to entitle NCM to

repayment of claims paid. Claims already paid are no longer a liability, and there is no reason to strain the policy wording so as to produce, as NCM would suggest, the equivalent of avoidance ab initio in reliance on some minor breach of a stipulation late on in the policy…’

Buxton LJ: ‘I agree with Waller LJ as to the correct approach to what has been called Article 13.1 of this singularly ill-drafted clause. I regret that I am unable to agree with him as to Article 13.2. The point is a short one, and does not admit of much elaboration. The words “and all liability under it” must be given some force. Mr Mildon was reduced to saying that they were a belt and braces provision: that is to say, mere surplusage. The same, unacceptable, outcome flows from the construction of that phrase as limited to liabilities flowing from the continuation of the policy: because the previous phrase in the clause terminates the policy and therefore excludes any need to provide, indeed any possibility of providing, for liabilities arising on its continuation. What by its plain wording the clause provides is that the written notice terminates the insurer’s liability under the policy: and that must mean not only purely future but also contingent liabilities, since the insurer is protected from entirely new liabilities by the termination of the policy. That no doubt produces unattractive, or potentially unattractive, results under Article 1.B of the policy, which happens to be this case, if it is clear that the period of grace will not result in payment being forthcoming. That problem does not arise under any of the other sub-heads of Article 1, such as insolvency of the buyer or political moratorium on debts, which do not involve a period of suspense. And however unattractive the result in a particular case, that result cannot be allowed to force on the contract a meaning that its words will not bear.

I therefore consider that the judge was right in his construction of the clause. I would dismiss the appeal.’

Peter Gibson LJ: ‘This appeal raises a short but difficult question of construction of two sentences in an insurance policy… In the circumstances it is not surprising to find Mr Spearman insisting that the clear words of Article 13 should be given their natural and ordinary meaning while Mr Mildon submits that an over literal approach is inappropriate where the consequences can be seen to be so extravagant. The court is entitled to look at those consequences because the more extreme they are, the less likely it is that commercial men will have intended an agreement with that result. But the court is not entitled to rewrite the bargain which they have made merely to accord with what the court thinks to be a more reasonable result, and the best guide to the parties intentions remains the words which they have chosen to use in the contract. Mr Spearman’s primary submission was that because the due payment of all premiums and the due performance and observance of every stipulation are a condition precedent to any liability on the insurers part, the failures by the insured entitled the insurer not merely to terminate the policy and all liability under it for the future but also to recover moneys paid out before that termination. Like my Lords I cannot accept that submission, essentially for the reasons given by the judge. In particular I am unable to agree that the parties thereby intended that throughout the term of the policy claims met by payment by the insurer could be reopened in the event of any subsequent breach. The language of Article 18 which, where it applies, expressly provides for the refund of any payment made under the policy, may be contrasted with the language of Article 13. I entirely agree with what Waller LJ has said on the construction of Article 13(1).

The more difficult question is the meaning to be given to Article 13(2)… I can accept that all liability under the policy does not include liabilities which have crystallised and been paid. It is inappropriate to refer to terminating such a liability. Indeed it may be questioned whether it is a liability at all once it has been discharged. I can also accept that if a liability has accrued unconditionally, for example if the insurer has delayed payment after it became due, it will not be caught by the termination. It cannot have been contemplated that the insurer could benefit from its own breach. But it is hard to see how all future or contingent liabilities under the policy are not terminated on the plain wording of the clause…[T]he concluding words of Article 13(2) cannot refer to liabilities flowing from the continuation of the policy or be limited to entirely new liabilities as protection from them is achieved by the termination of the policy. Further, if all liability under the policy is to be construed as not including a contingent liability in respect of which obligations under the policy have been fulfilled, which obligations have that character? Is it sufficient that the insurer has made a declaration or must he also have paid the premium? I find it difficult to see how on the language used it is possible to distinguish between contingencies affecting the insureds liability. The more natural way of construing Article 13(2) is to treat all contingent liabilities as falling within all liability under the policy and so as terminated. I dislike the notion that an insurer will by contract be entitled both to retain a premium and to be released from the cover which that premium was intended to purchase. But I cannot say that a contractual provision to that effect triggered by the default of the insured is so outrageous that effect cannot be given to the ordinary meaning of the

language of the policy in order to achieve a less harsh result. With regret therefore I would dismiss this appeal.’

8.6.1 Innominate Terms In an attempt to inject some consistency into the classification of insurance terms with that of the general law of contract, the Court of Appeal (Peter Gibson, Waller and Buxton LJJ) recently enlisted the terminology of ‘innominate terms’ when determining the nature of a notice of loss clause (below, [823]). The legal consequences depend upon the effects of the breach for the insurers. If the effects are not serious the insurers will have to pay the claim and sue the insured for damages for any loss suffered. Where, on the other hand, the insurers suffer serious harm they can treat the policy as terminated for repudiation or they can repudiate the claim: [823] Alfred McAlpine plc v BAI (Run-Off) Ltd [2000] Lloyd’s Rep IR 352 (CA) [A workman who was engaged on the construction of a bridge suffered severe personal injuries when he fell through the scaffolding to the ground. He was employed by Moss, the firm responsible for the concreting work under a sub-contract with RC Construction Ltd. (RCCL). RCCL contracted for the works with McAlpine who had erected the scaffold. The workman successfully sued Moss and McAlpine as co-defendants. McAlpine joined RCCL as third

party claiming an indemnity. RCCL was insured with BAI. Under the terms of the policy BAI agreed to indemnify RCCL against: “all sums which the Insured shall become legally liable to pay as compensation arising from… (a) accidental bodily injury to any person not being an Employee of the Insured”.

Under the heading “Claims Conditions”, clause 1(a) provided: “In the event of any occurrence which may give rise to a claim under this policy the insured shall as soon as possible give notice thereof to the Company in writing with full details…”

McAlpine obtained judgment against RCCL which could not be satisfied because RCCL had gone into liquidation. McAlpine therefore claimed as statutory assignee (under the Third Parties (Rights Against Insurers) Act 1930) of RCCL’s rights to recover in respect of its liability against BAI under the terms of the policy. BAI denied liability arguing that RCCL had failed to provide adequate and prompt notice of the claim and was therefore in breach of clause 1(a) which was a condition precedent to its liability. The 1930 Act preserved any defences available to the insurer. BAI also claimed that failure to comply with clause 1(a) was a repudiatory breach of contract or a breach of the insured’s duty of utmost good faith and that BAI accepted its conduct as a repudiation. BAI also

argued that the failure of RCCL to comply with the requirement for notice prejudiced BAI and accordingly the non-compliance operated as a defence to the claim under the policy]. Waller LJ: ‘…the issue on the appeal, relates to a condition in a policy of insurance requiring the insured to give notice of any occurrence which may give rise to a claim “as soon as possible…in writing, with full details”. BAI submitted before the Judge that the condition was a condition precedent, and that failure to comply relieved the insurer from any liability. Alternatively they submitted that the failure to comply amounted to a breach of the insured’s duty of good faith or amounted to a repudiation of the contract of insurance, and that the insurers avoided the contract or accepted such repudiation and that on that basis there was no liability under the policy. The plaintiffs (McAlpine) submitted that if there was a failure to comply with the condition that simply gave rise to a right to damages, and that BAI had failed to establish any such claim. Colman J preferred the arguments of McAlpine. BAI appeal against that judgment. By a supplemental skeleton argument they did however make clear that they did not seek to disturb the Judge’s finding that the condition did not constitute a condition precedent…

The law As the Judge commented, the law as to the effect of notice clauses of this nature is remarkably unsettled. But at least on one point there was no argument before us because there was no challenge to the Judge’s finding that condition 1(a) was not a condition precedent.

Once that point is disposed of, the question is what remains, having regard to the fact that at least by the time these proceedings had been commenced BAI did have full details of the incident from McAlpine. If BAI could establish a repudiation of the contract of insurance or a failure to act in good faith, and establish that they accepted that repudiation or avoided the contract, then they would be entitled to resist liability. This is their pleaded case. As to breach of good faith, I am at present not absolutely clear what is alleged. There is no allegation of dishonesty. It is not said, for example, that personnel within RCCL, knowing that the incident might lead to a claim under the policy with BAI, deliberately decided to conceal the fact that the incident had taken place in order to make it impossible for BAI to investigate the claim. I assume that all that is relied on is the non-supply of full details… [W]e come unhesitatingly to the conclusion in the present case that no enlargement of the duty not to make fraudulent claims, so as to encompass claims made “culpably”, is warranted…In our judgment there is no warrant for any widening of the duty so as to embrace “culpable” non-disclosure. Either it does not enlarge the scope of fraud, in which case it is not needed, or it does, in which case the extent of the enlargement is unclear and the concept should be rejected. In my view mere negligence in supplying details of a claim cannot constitute a breach of the obligation of good faith… As regards repudiation of the contract as a whole, as the Judge pointed out it is not easy to contemplate that a failure to comply with an ancillary provision relating to one claim under a policy could amount to a repudiatory breach of the whole contract of insurance. He said: “The notification clause in the policy is one of a number of provisions which, as I have held, are ancillary to the

entitlement of the assured to claim to be indemnified under the policy. In other words, they are not in themselves ordinary promissory terms which can be characterized as conditions in the contract properly so called or innominate terms. Mere non-compliance could not amount to a repudiatory breach of the whole policy. It would by its nature, as I have explained, affect only the particular claim arising from the occurrence which had not been timeously or insufficiently full detail notified to the insurers and not subsequent claims under the policy…” What however is argued is that “prejudice” suffered by the insurer can turn a breach into a repudiatory breach… I do not myself think that the choice should necessarily lie between a construction which would involve condition 1(a) being a condition precedent, and condition 1(a) simply giving rise to a claim for damages. It seems to me that once a condition such as condition 1(a) is construed as something less than a condition precedent, it will still be important to ascertain precisely what its contractual effect is intended to be and what the effect of a breach of that term will be. For example, if no details of the incident in relation to which RCCL was making its claim were ever supplied, despite the insurers’ requests for them, would BAI still be bound to pay, and simply be left with a remedy in damages for breach of the condition? Certainly if the consequences for BAI were that they had been seriously prejudiced, it seems to me unreasonable that that should be so. Accordingly it seems to me one should consider the possibility that a breach of condition 1(a) might in some circumstances be so serious as to give a right to reject the claim albeit it was not repudiatory in the sense of enabling BAI to accept a repudiation of the whole contract. The very fact that condition 1(a) is aimed at imposing obligations in relation to individual claims which BAI might be obliged to pay, ought

logically to allow for the possibility of a “repudiatory” breach leading simply to a rejection of a claim… In considering this question, and on referring to a textbook on reinsurance law not cited to us at the original hearing, Butler & Merkin Reinsurance Law para C4.3–07, I noted a case referred to in the footnotes which appeared to have addressed this problem. That case Trans-Pacific Insurance Co (Australia) Ltd v Grand Union Insurance Co Ltd (1989) 18 NSWLR 675…a decision of Giles J, seemed to me to assist… That case was concerned with a marine reinsurance second surplus treaty. On the placing slip had been added the words “(d) claims cooperation clause”. No such clause however had ultimately been spelt out in the reinsurance treaty. That treaty enabled certain risks to be ceded to the treaty. The parties had at all times conducted themselves upon the basis that the treaty gave rise to binding obligations between them and in relation to one particular claim the reinsured had refused to provide further information pending acknowledgement of liability by the reinsurer and consequent thereon the reinsurer had purported to avoid the whole treaty. However at the hearing the reinsurer abandoned the argument as to avoidance of the whole treaty and simply argued an entitlement to avoid liability in relation to the particular claim. Giles J held that there was no standard cooperation clause and that thus the slip should be read as stating and doing no more than stating that the reinsured should co-operate with the reinsurer in relation to claims. He further held that as a matter of construction the manuscript addition “claims co-operation clause” did not import a condition precedent to the reinsurers’ liability. Furthermore, although he did not expressly deal with the point, he did not construe the term as one entitling the reinsurer not to pay until there had been full compliance with the condition. That however as we shall see, was the effect of his judgment. It is fair to say that he also held that where there is a notification and a cession of a risk to a

reinsurance treaty then upon “that act a separate contract of reinsurance in relation to the particular risk is concluded.” This point is understandably stressed by Mr Lynagh in his submissions on this authority. Giles J was thus able to approach the matter on the basis that the risk in relation to which the reinsurer was repudiating liability was a risk under a separate contract. He then considered the nature of the term in the reinsurance treaty and in his language concluded that it did not have the “essentiality” such that any breach would entitle the reinsurers to terminate their contractual obligation in relation to the claim being made. He then however continued…as follows: “I note that, in Phoenix General Insurance Co of Greece SA v Halvanon Insurance Co Ltd [1988] QB 216 at 241… Hobhouse J commented that certain implied terms relating to keeping full and proper records, investigating claims, and making records available on request to a reinsurer were ‘innominate’ (which in current terminology distinguishes them from essential terms, see Hong Kong Fir Shipping Co Ltd v Kawasaki Kisen Kaisha Ltd [1962] 2 QB 26) such that: …the consequences of any breach for any particular cession or any individual claim or, indeed, for the contracts as a whole, must depend on the nature and gravity of the relevant breach or breaches.” Apart from illustrating obligations of a similar nature to the claims co-operation obligation being viewed otherwise than as essential, it may be observed that his Lordship envisaged that breach may have consequences for a particular cession or an individual claim. Thereafter he concluded: “I do not think that by the breach of the claims co-operation obligation Trans-Pacific evinced an intention no longer to be bound by the reinsurance contract relating to the “New Dolphin” or showed that it intended to fulfil the contract

only in a manner obligations.”

substantially

inconsistent

with

its

Thus on the facts of the particular case he held that the reinsurer was not entitled to reject the particular claim. It seems to me that condition 1(a) does not have what Giles J described as a quality of “essentiality” for the reasons he gave in relation to the co-operation clause in that case. He said that it must have been obvious that there could be major or minor failures to co-operate, disagreement on what did or did not amount to cooperation, or breaches which could be readily rectified without any prejudice to the reinsurer. The same goes for the supply of details. Indeed this case exemplifies how a breach may be major or minor in that certainly some details were supplied to BAI and details which would have been sufficient to enable BAI to make such enquiries as it needed. I see no reason however why condition 1(a) should not be construed as an “innominate” term as per Hong Kong Fir Shipping (sup) where the consequences of a breach may be so serious as to entitle BAI to reject the claim albeit the breach is not so serious as to amount to a repudiation of the whole contract. Mr Lynagh submits there is no support in the judgment of Giles J for the proposition that the consequences may be so serious as to give a right to reject the claim. I accept that Giles J took the view that there was a separate contract of reinsurance in relation to the risk the subject matter of that case, and thus did not decide the point. But I do think the inference to be drawn from the passage quoted…of Giles J supports the view that I take. I accept Mr Walker’s submission in this regard. It seems to me that the payment of individual claims are severable obligations and that where an insured is bound to carry out one obligation in order to receive the benefit of the insurer’s obligation by implication the insured is accepting that if he

fails in a serious way to carry out his part of that bargain he will not receive what he has bargained for. Thus the correct analysis of condition 1(a) I would suggest should be as follows. Compliance with condition 1(a) is not by the policy made a condition precedent to liability, thus it is not enough for BAI to establish a failure to supply full details as soon as possible in order to resist the claim. That much is conceded. Condition 1(a) is however 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. It has not in fact been pleaded in this case that there was a breach with serious consequences entitling BAI to reject the claim as opposed to accept repudiation of the whole contract. However during argument some attention was focused on this aspect and it may be said that it formed part of the argument based on Taylor. On a proper understanding of Taylor it was however bound to fail unless BAI could demonstrate that there was a serious breach of condition 1(a) which had serious consequences and that in reliance on such a breach the claim had been rejected. In my view the breach of condition 1(a) in this case was very limited in that BAI had sufficient details to enable them to investigate the claim. Furthermore, by the time BAI had at least some

details of the claim they had not suffered any irremediable prejudice… Full details were ultimately supplied on any view by McAlpine and in so far as it was open to Mr Walker to argue that BAI were entitled to defeat the claim because full details had never been supplied by RCCL, (and I have some doubt whether on the pleadings it was so open), I would reject that argument. Thus, although going part of the way with Mr Walker’s submission on the Trans-Pacific Insurance case, I cannot accept his ultimate conclusion.’

Notes: 1. See also, Bankers Insurance Co Ltd v South [2003] EWHC 380 (below, [838]). 2. See J. Davey [2001] JBL 179 who, commenting on the decision in McAlpine, observes: ‘This increased flexibility of remedy for the giving of late notice is a marked improvement on the rigours of conditions precedent…However, the use of such standard contractual principles as innominate terms must be carefully controlled to avoid the conceptual difficulties now evident following Waller LJ’s “breach of contract” analysis.’ 3. As seen in relation to the construction of warranties, the judges may adopt the contra proferentem principle of construction when determining whether or not a condition is a condition precedent to the liability of the insurer (contrast the approach of the majority of the Court of Appeal in Re Bradley (below, [824]) with that of Fletcher-Moulton LJ). As with

promissory warranties, the fact that a particular label is applied to a policy term is not necessarily conclusive as to its nature (see George Hunt Cranes Ltd v Scottish Boiler and General Insurance Co Ltd [2002] 1 All ER (Comm) 366 (below, [828])). [824] Re Bradley and Essex & Suffolk Accident Indemnity Society [1912] 1 KB 415 (CA) [The facts appear from the judgment of Cozens-Hardy MR]. Cozens-Hardy MR: ‘This is an appeal from a decision of Bray J, who has held that a particular condition in a policy is not a condition precedent. The plaintiff, Bradley, is a currier and small farmer. His only employee was his son, who met with an accident on 15 February 1909, in respect of which he has obtained compensation from his father at the rate of 6s. per week. The propriety of this compensation is not questioned. The father claims under the policy which he effected on 31 March 1908. The proposal, which is to be “considered as incorporated in the policy,” stated the estimated number of employees as one to two, and their total estimated wages at £75. It gave other particulars, upon which no question arises, and at the end there is a statement that Bradley desired to effect an insurance “in terms of the policy to be issued” by the society against his statutory and common law liability, and he agreed to render at the end of each period of insurance a statement in the form required by the company of all wages actually paid and to pay premium on the wages paid in excess of the amount estimated above. The premium paid was 10s [50p]. The policy itself refers to

the proposal, which is agreed to be the basis of the contract, and it witnessed that in consideration of the payment to the society of 10s. premium — which premium “is subject to adjustment as hereinafter provided” — for indemnity from 28 March 1908, to 1 April 1909. After stating the extent of the indemnity, which includes claims under the Workmen’s Compensation Act, there is a proviso in the following terms: “Provided always that the due observance and fulfilment of the conditions of this policy, which conditions are to be read as part of this policy, shall be a condition precedent to any liability of the society under this policy.” Then follow eight conditions. Now it is perfectly clear that some of these so-called conditions are not and cannot be conditions precedent, although some of them may be and are conditions precedent. Nos 1 and 2, dealing with notices, may be conditions precedent. No 3, so far as any meaning can be attributed to it, seems to me not to be a condition precedent. The same remark applies to Nos 4, 6, and 7. The question in this appeal, however, turns upon condition 5. This is obviously that which is referred to in the policy itself in the words “subject to adjustment as hereinafter provided.” The first sentence is not a condition precedent. That says “The first premium and all renewal premiums that may be accepted are to be regulated by the amount of wages and salaries and other earnings paid to employees by the insured during each period of insurance.” The third sentence also is not. It says “The insured shall at all times allow the society to inspect such books, and shall supply the society with acorrect account of all such wages, salaries, and other earnings paid during any period of insurance, within one month from the expiry of such period of insurance, and if the total amount so paid shall differ from the amount on which premium has been paid, the difference in premium shall be met by a further proportionate payment

to the society or by a refund by the society, as the case may be.” The second sentence is in the following words: “The name of every employee, and the amount of wages, salary, and other earnings paid to him, shall be duly recorded in a proper wages book.” It is found by the arbitrator, who has made his award in the form of a special case, that this small farmer did not keep any wages book, and the question is whether this suffices to relieve the society from all liability, or whether it is merely a part of the provision for adjusting the premium and evidencing the amount of wages in respect of which premium was payable. Bray J has held that the policy holder is not disentitled to claim by reason of the omission to keep a proper wages book, and I agree with his decision. I think the fifth condition is one and entire, and it is to my mind unreasonable to hold that one sentence in its middle is a condition precedent while the rest of the condition cannot be so considered. A policy of this nature, in case of ambiguity or doubt, ought to be construed against the office and in favour of the policyholder, and it seems to me unreasonable to hold that the office can escape from all liability by reason only of the omission to duly record in a proper wages book the name of every employee and the amount of his wages. This is only required for the purpose of the statement which, by the proposal, the insured agreed to render at the end of each period of insurance. In my opinion, it ought not to be regarded as in any sense a condition precedent, and it follows that, in my opinion, the appeal fails and must be dismissed with costs.’

Fletcher-Moulton LJ (dissenting): ‘…was compliance with clause 5 of the policy a condition precedent to the liability of the society under the said policy?

In my opinion, this question is purely a question of construction and is unaffected by the special facts of the case. But it may be well to state here one or two facts which were referred to in the arguments. They are as follows: The claimant signed in the first place a proposal for the policy, in which he stated that the estimated number of employees was one to two. He was a currier and farmer, and at the time of signing such proposal and during all material times he only employed one workman, namely, his son. The son’s wages were £1 a week and board. In chopping wood the son last his hand. No question arises about the injury or the amount of the compensation to be paid in respect of it. …clause 5 (upon the interpretation of which the present case turns) is inserted in the policy as one of the conditions. These conditions are subject to a proviso which is in the following words: “Provided always that the due observance and fulfilment of the conditions of this policy, which conditions are to be read as part of this policy, shall be a condition precedent to any liability of the society under this policy.” Clause 5 reads as follows: “The first premium and all renewal premiums that may be accepted are to be regulated by the amount of wages and salaries and other earnings paid to employees by the insured during each period of insurance. The name of every employee and the amount of wages, salary, and other earnings paid to him shall be duly recorded in a proper wages book. The insured shall at all times allow the society to inspect such books and shall supply the society with a correct account of all such wages, salaries, and other earnings paid during any period of insurance within one month of the expiry of such period of insurance, and if the total amount so paid shall differ from the amount on which premium has been paid the difference in premium shall be met by a further proportionate payment to the society or by a refund by the society, as the case may be.”

There is no ambiguity in the language of this clause, and it is found by the arbitrator, and is an admitted fact in this case, that the claimant kept no record whatever of the wages paid by him. If, therefore, the observation of this condition is a condition precedent to liability under the policy (as the language of the policy expressly declares to be the case), the society are entitled to our judgment. But on certain grounds, which I shall presently examine, the learned judge has found that the parties did not intend the observance of the condition to be a condition precedent to liability under the policy, and has therefore given judgment for the claimant, and it is from this judgment that the present appeal is brought. Before dealing with the main point it is necessary to get rid of certain contentions which have been put forward during the argument, but which in my opinion have no real bearing on the question. In the first place, much emphasis was laid on the fact that the claimant here was a currier and farmer employing only one, or at most two workmen. I cannot see what relevance that fact has. It might have some bearing on the interpretation of the phrase “duly recorded in a proper wages book,” inasmuch as a proper wages book for a large employer might be of a different kind to a proper wages book for a small employer. But in the present case it is found by the arbitrator that he did not perform this condition at all. No wages book was kept and no entry made, so that, however leniently the Court might be inclined to construe those words in the case of a small employer, it is impossible to say that he performed the condition. It is for this reason that I am of opinion that the case before us is a pure question of law, namely, the construction of the contract. And if we decide that the performance of this obligation is not a condition precedent in the present case, that ruling will apply to every policy of the society.

It was further sought to base an argument on the fact that there is no reference to this condition in the proposal form which was signed by the claimant. That is true, but I fail to see what bearing that has on the question before us. That proposal was only a proposal for a policy in the form used by the society. It did not purport to contain the conditions of the policy, and indeed it did not refer to any one of those conditions excepting the rendering of a statement in the form required by the company of all wages actually paid and the payment of premium on the excess over the estimate. It expressly states that signing the proposal form does not bind the applicant to complete the insurance. It is not, nor could it be, suggested that the applicant thought that the proposal form was the policy or included all its terms. But it is not necessary to enlarge on this point, because this is not a case in which the insured is disclaiming the policy as not being in accordance with that which he intended to enter into; he is himself claiming under the policy, and he cannot be allowed to claim under the policy and yet contend that he is not bound by its terms. I now come to the main question as to the due observance and fulfilment of clause 5 being a condition precedent to the liability of the society under the policy. It is clearly and unmistakably pronounced to be so in the policy itself, and I ask myself whether there is any reason why we should declare it to be otherwise. I can see none. The clause appears to me to be a most reasonable precaution necessary for the protection of the society and wisely made by it a condition precedent. By the scheme of insurance the premium is fixed not at the inception of the risk but after it is over, and the amount of the premium is calculated upon the total of the wages actually paid within the year. It follows that if there is any omission, either of persons employed or of wages paid to them, in calculating the adjustment, the society gets a diminished premium. By the time the adjustment has to be made the risk is over, and

therefore it is directly to the interest of the insured to make such omissions. But if the insured is bound to keep a contemporary record of the names of his employees and the wages paid to them, there is no such temptation to him to fail in his duty, because the risk is not then over, and, as he wishes to be covered for all his employees, he necessarily has an interest in entering them as such at the time. It will be seen, therefore, that the duty of making contemporary records of the names of the employees and of the wages paid is a most valuable protection to the company against fraud or forgetfulness on the part of the insured. I may go further and say that it is in substance their only protection. It would be impossible for them actually to check the correctness of the statements as to the employees and their wages which are rendered to them by the insured at the end of the year, since they probably have many thousands of policies. But by making it a condition that all wages shall be duly recorded in a proper wages book, and that such wages book shall at all times be open to the inspection of the society, the latter has a really effective check upon the insured. It becomes much too dangerous to leave unrecorded the wages paid, and in this way the insured are spared the temptation of omitting to make records of wages paid to persons with regard to whom the risk is over, such as persons taken on temporarily whose period of service has expired. To my mind a provision such as this is precisely correlative to a condition that notice of an accident shall be given as soon as practicable. The latter protects the society from unfounded claims of liability by putting it in the best position for testing the justice of the claims, and the former protects the society from loss on its premiums by providing that it shall have the best material for checking their correctness. And these two conditions are alike in another respect. However vital to the society their observance may be, they can only be rendered effective by stipulating that they shall be conditions precedent, ie, that a plaintiff, in

order to make good his claim, must aver and prove their performance down to the date of bringing the action. If they are merely independent obligations, the breach of which gives ground for a cross-claim in damages, they might as well be struck out of the policy, because from their nature it is impossible to establish the quantum of damage resulting from a breach. The condition therefore seems to me to be one of such a nature that it can be made, and would naturally be made, and by the language of the policy has expressly been made, a condition precedent, and, inasmuch as, ex concessis, it has not been performed in this case, I am of opinion that the liability of the society under the policy has ceased…’ For these reasons I am of opinion that the appeal should be allowed and the action dismissed with costs here and in the Court below.’

Farwell LJ: ‘Contracts of insurance are contracts in which uberrima fides is required, not only from the assured, but also from the company assuring. It is the universal practice for the companies to prepare both the form of proposal and the form of policy: both are issued by them on printed forms kept ready for use; it is their duty to make the policy accord with and not exceed the proposal, and to express both in clear and unambiguous terms, lest (as Fletcher Moulton LJ, quoting Lord St. Leonards, says in Joel v Law Union and Crown Insurance Co [1908] 2 KB 863, 886) provisions should be introduced into policies which “unless they are fully explained to the parties, will lead a vast number of persons to suppose that they have made a provision for their families by an insurance on their lives, and by payment of perhaps a very considerable portion of their income, when in point of fact, from the very commencement, the policy was not worth the paper upon which it was written.” It is especially incumbent on insurance companies to make

clear, both in their proposal forms and in their policies, the conditions which are precedent to their liability to pay, for such conditions have the same effect as forfeiture clauses, and may inflict loss and injury to the assured and those claiming under him out of all proportion to any damage that could possibly accrue to the company from non-observance or non-performance of the conditions. Accordingly, it has been established that the doctrine that policies are to be construed “contra proferentes” applies strongly against the company…These considerations are particularly applicable to insurances under the Workmen’s Compensation Act; that Act has rendered it practically necessary for all who desire to avoid the risk of bankruptcy, and who cannot afford to be their own insurers, to insure. Tens of thousands of small shopkeepers with one assistant, lodging-house keepers and others with one “general,” small farmers, tenants of small holdings and the like with one man, are driven to insure. They receive a printed form of proposal, and it is reasonable to assume that they read and rely on it, and they receive in exchange for the form so supplied to and required from them a policy which they are entitled to assume and do assume, in most cases without careful perusal of the document, to accord with the proposal form. It is, in my opinion, incumbent on the company to put clearly on the proposal form the acts which the assured is by the policy to covenant to perform and to make clear in the policy the conditions, non-performance of which will entail the loss of all benefits of the insurance. It is contended that it is of the utmost importance to insurance companies that they should be able to defend themselves against frauds by inserting conditions precedent, such as keeping wages books, and the like. Be it so; there is no objection whatever to the insertion of such conditions, so long as the intending assurer has full and fair notice of them and consents to them. This can easily be done by stating them shortly in the proposal forms with the addition that payment may be refused if they or

any of them are not complied with; but it is, in my opinion, scarcely honest to induce a man to propose on certain terms, and then to accept that proposal and send a policy as in accordance with it when such policy contains numerous provisions not mentioned in the proposal, which operate to defeat any claim under the policy, and all the more so when such provisions are couched in obscure terms. In the present case both proposal form and policy offend against both the requirements to which I have referred, and the form of policy is to my mind very objectionable. The insured is a currier and farmer who employs one man only, his own son. The condition precedent for non-performance of which the society claims to escape liability is the failure to keep a “proper wages book.” The proposal form says nothing about keeping a wages book, but contains these words: “I agree to render, at the end of each period of insurance, a statement in the form required by the company of all wages actually paid and to pay premium on the wages paid in excess of the amount estimated above.” There is no question here of actual payment of the wages: the arbitrator has found that the wages were paid; it is a perfectly honest claim. There is nothing in the proposal form to suggest to a man who employs one workman only the necessity of keeping a wages book at all, nor is there any evidence that it is usual or proper for a currier or farmer employing one man only to keep such a book: in the absence of evidence I decline to assume it, and all the more so because I feel sure that the contrary is the fact. Then I turn to the policy, and I find a provision that may be common, but is in my opinion most objectionable: the policy states that the due observance and performance of the conditions of this policy “shall be a condition precedent to any liability of the society under this policy.” The policy then sets out in small print eight clauses, of which it is admitted that several are not conditions precedent, and some are not conditions at all. Clause 5 contains the provision relied on by the society: it is in the

middle of a clause, the first and last provisions of which are clearly not conditions precedent. The first paragraph is not a condition at all, and the last is obviously subsequent, because the amount due on the policy may become due before the event happens, and Bray J has held that the provision for keeping a proper wages book, inserted as it is in the middle of clause 5, cannot fairly be read as an independent condition precedent, but is merely machinery for that ascertainment and adjustment of premium which is mentioned in the proposal form. I agree with him, because I think that, reading the policy with the proposal form (in accordance with the provision in the form that the form is incorporated in the policy), and construing the policy most strongly against the society, in the interests of honesty and fair dealing this is the better construction: any other construction would convict the society of having issued a tricky policy calculated to deceive and entrap the unwary and of insisting on the success of their devices. I think it is the duty of all insuring companies to state in clear and plain terms, as conditions precedent, those provisions only which are such, not to wrap them up in a number of clauses which are not conditions precedent at all; and I think further that it is their duty to call attention to such conditions in their form of proposal so as to make sure that the insurers understand their liabilities…There is another ground on which also I think Bray J’s judgment can be supported. The condition, if it be one, is to keep “a proper wages book”: that must mean, in my opinion, “proper under the circumstances of the case and for the business or trade of the insurer.” Take the case of a lodging-housekeeper with one maid. I think it would be absurd to lay it down as a matter of law without evidence that it is proper or usual for such a woman to keep a wages book; and I think the same observation applies to a small farmer (even although he adds a currier’s business to his farming) who employs his son as his only servant. I think

Bray J was right, and this appeal should be dismissed with costs.’

Notes: 1). Re Bradley amply illustrates that construing the language found in policy documents is not a straightforward exercise and judges sitting together considering the same words or phrase in a policy may come to different conclusions. This lack of consistency is seen to pervade much of the case-law where very similar policy terms are accorded different meanings with the result that it is difficult to anticipate what consequences will necessarily follow an insured’s breach (compare the decisions in the Conn and W & J Lane cases (below, [826] and [827] respectively) 2). In this regard, it is noteworthy that the House of Lords in Charter Reinsurance Ltd v Fagan (below, [825]) paid considerable attention to the inherent difficulties of interpreting language when attempting to determine the contractual intention of the parties. [825] Charter Reinsurance Co Ltd v Fagan [1997] AC 313 (HL) [A reinsurance policy provided that the reinsurers were not to be liable to make payment to the reinsured until the reinsured ‘shall actually have paid’ its own policyholders. The material terms were as follows:

“Liability clause The Reinsurers shall only be liable if and when the Ultimate net Loss sustained by the Reinsured in respect of interest coming within the scope of the Reinsuring Clause exceeds £3,000,000 or US or Can.$6,000,000 each and every loss and/or Catastrophe and/or Calamity and/or Occurrence and/or Series of Occurrences arising out of one event and the Reinsurers shall thereupon become liable for the amount in excess thereof in each and every loss, but their liability hereunder is limited to £2,000,000 or US or Can.$4,000,000 each and every loss and/or Catastrophe and/or Calamity and/or Occurrence and/or Series of Occurrences arising out of one event.

Ultimate net loss clause The term ‘Net Loss’ shall mean the sum actually paid by the Reinsured in settlement of losses or liability after making deductions for all recoveries, all salvages and all claims upon other Reinsurances whether collected or not and shall include all adjustment expenses arising from the settlement of claims other than the salaries of employees and the office expenses of the Reinsured.”

The issue was whether the ultimate net loss clause constituted a condition precedent to the reinsurers’ liability or whether the reinsured could recover upon proof of its liability to make payment as opposed to having actually paid]. Lord Hoffmann: ‘My Lords, this appeal turns upon the construction of a standard clause known as the ultimate net loss (“U.N.L.”)

clause which is in common use in the London excess of loss reinsurance market. Although the action concerns three particular policies of reinsurance written on behalf of two Lloyd’s syndicates, it raises an issue which affects the whole reinsurance market. …The question is whether the words “actually paid” mean that the liability of the reinsurers is limited to the sum in respect of which Charter Reinsurance has discharged its liabilities in respect of the risks which it insured. Mr Sumption [counsel for the reinsurers] says that this is the natural meaning of the words. There is nothing in the context which requires them to be given a different meaning and that is the end of the matter. I think that in some cases the notion of words having a natural meaning is not a very helpful one. Because the meaning of words is so sensitive to syntax and context, the natural meaning of words in one sentence may be quite unnatural in another. Thus a statement that words have a particular natural meaning may mean no more than that in many contexts they will have that meaning. In other contexts their meaning will be different but no less natural. Take, for example, the word “pay.” In many contexts, it will mean that money has changed hands, usually in discharge of some liability. In other contexts, it will mean only that a liability was incurred, without necessarily having been discharged. A wife comes home with a new dress and her husband says “What did you pay for it?” She would not be understanding his question in its natural meaning if she answered “Nothing, because the shop gave me 30 days’ credit.” It is perfectly clear from the context that the husband wanted to know the amount of the liability which she incurred, whether or not that liability has been discharged. What is true of ordinary speech is also true of reinsurance…

But, said Mr Sumption, there is the word “actually”…“Actually paid” said Mr Sumption, meant actually paid. One speaks of something being “actually” the case to point a contrast; perhaps with what appears to be the case, or with what might be the case, or with what is deemed to be the case. The effect of the word therefore depends upon the nature of the distinction which the speaker is wanting to make. This can appear only from the context in which the phrase is used. It is artificial to start with a contextual preconception about the meaning of the words and then see whether that meaning is somehow displaced… To revert to my domestic example, if the wife had answered “Well, the dress was marked £300, but they were having a sale,” and the husband then asked “So what did you actually pay?” she would again be giving the question an unnatural meaning if she answered “I have not paid anything yet.” It is obvious that the contrast which the husband wishes to draw is between the price as marked and the lower price which was charged. He is still not concerned with whether the liability has been discharged. This is not a loose use of language. In the context of the rest of the conversation, it is the natural meaning. What then is the context?…My noble and learned friend, Lord Mustill, has analysed the structure of the policies and for the reasons which he gives, I agree that the context points to a wish to emphasise the net character of the liability as opposed to what, under the terms of the policies, the liability might have been… Mr Sumption suggested a stratagem which insurers might use to avoid having to pay the whole claim themselves. They could pay a part, even a very small part, of the reinsured liability and then, having to this extent actually paid, they could call upon the reinsurer to reimburse them. Having thus primed the pump, they could by successive strokes draw up the full amount from the reinsurance well. I

cannot imagine that the parties could ever have contemplated such a strange procedure and one is bound to ask what commercial purpose the reinsurer could have expected to achieve by being able to insist upon it. Considerations of history, language and commercial background therefore lead me to the conclusion that the word “actually” in the U.N.L. clause is used to emphasise that the loss for which the reinsurer is to be liable is to be net and that the clause does not restrict liability to the amount by which the liability of the reinsured for the loss has been discharged. I think that this is the natural meaning of the clause.’

[826] Conn v Westminster Motor Insurance Association [1996] 1 Lloyd’s Rep 407 (CA) [The policy contained the following terms: “1. The due observance and fulfilment of the terms provisions conditions and endorsements of this Policy in so far as they relate to anything to be done or complied with by the Policyholder shall be conditions precedent to any liability of the Company to make any payment under this Policy… 5. The Policyholder shall take all reasonable steps to safeguard from loss or damage and maintain in efficient condition the vehicle or vehicles described in the Schedule hereto and the Company shall have at all reasonable times free access to examine any or all such vehicles.”

The insured, a taxi driver, was driving with two passengers along clear road on dry night when his vehicle turned off road and collided with railings on a kerb. The insured and his passengers sustained

personal injuries and the taxi was a write-off. The passengers were idemnified by the insurers and the insured sought to recover in respect of the loss of the taxi. The insurers denied liability and counter-claimed for indemnity in respect of the sums paid to the passengers. They argued that the taxi was not maintained in an efficient condition in that its tyres were badly worn and its brakes were defective; that the insured was in breach of condition 5 which was declared a condition precedent to liability by condition 1. Sellers LJ, sitting as an additional Judge of the Queen’s Bench Division, held that that ‘efficient condition’ was related to efficiency of vehicle and that as the brakes and tyres had not been shown to be inefficient, and were not the cause of the accident the insured was entitled to recover under policy. The insurers appealed]. Davies LJ: ‘The first question in this case (and I confine my observations entirely to the tyres) is: Have the defendants proved that the vehicle was not in an efficient condition, using the words of Condition 5 in the Conditions of the policy? In my view…there is only one possible answer to that, namely, that the vehicle was plainly not in an efficient condition in view of the state of the two front tyres. The learned Lord Justice in the Court below used this phrase ([1966] 1 Lloyd’s Rep at p 131): “As I have said with regard to the brakes, no evidence has been brought to show that these tyres were in fact inefficient…”

With the greatest respect, I wholly disagree. The witnesses described the condition of the tyres as “dangerous”, “unsafe”, “unserviceable” and “unroadworthy”. After the sentence that I have just quoted, Sellers LJ goes on to point out that this taxi-cab had been running for some time without any accident, and therefore it is to be supposed that it was efficient to the extent that nothing untoward had happened. I do not think that a vehicle with tyres in the state in which these tyres unquestionably were can possibly be said to be efficient merely because the driver of the vehicle had had the good luck not to have anything go wrong during the latter period of the wearing away of the tyres. It seems to me, therefore, that the defendants have plainly proved that this vehicle was not in an efficient condition. That conclusion is not at all affected by the fact that the police in 1960, when this accident occurred, chose to prosecute the driver (the plaintiff) only in respect of his brakes and not in respect of the tyres. That being so, did the plaintiff take reasonable steps to maintain the vehicle in an efficient condition? He took no steps at all; that is admitted. Admittedly he knew that the near-side tyre had no tread. He says that he did not know that the off-side tyre had no tread and was down to the canvas. But it seems to me quite impossible to imagine that, with knowledge of the condition of the near-side tyre, he would not look at and observe the condition of the off-side tyre. Did he know, or ought he to have known, the condition of those two tyres? Again, it appears that the answer to that is inevitably “Yes.” It was staring him in the face. He must have known the condition of both tyres. He must have known, as any car driver and particularly someone who has been driving a taxi-cab for very many years would know, that front tyres in that condition are unroadworthy and, indeed, unsafe. The last matter (and one on which the learned Lord Justice to some extent relied) was the fact that the plaintiff knew

that in some two or three weeks’ time this vehicle was going in for its annual overhaul, the kind of overhaul which he had had done to it year after year at quite considerable expense. It appears to me that that is an irrelevant consideration. If a man, whether taxi-driver, lorry-driver or motorist, knows that his vehicle in any respect is in such a condition as to be unroadworthy and possibly dangerous, it will not do to say: “Well, the vehicle is going in for annual overhaul in two or three weeks’ time. Therefore, it is all right for me to go about my business with the car now.” That seems to me to be quite wrong, and the sort of thing which I should have thought that this condition or policy was designed to prevent. …I agree that this appeal succeeds.’

[827] W & J Lane v Spratt [1970] 2 QB 480 [A new driver for the claimants who had been employed without a reference or identity check disappeared with a valuable lorry-load of bacon on his first day at work. Condition 9 of the claimants goods in transit policy provided: “Due Diligence Clause. The insured shall take all reasonable precautions for the protection and safeguarding of the goods and/or merchandise and use such protective appliances as may be specified in the policy and all vehicles and protective devices shall be maintained in good order. Such devices shall be used at all times and shall not be varied or withdrawn without written consent by the underwriters. It is the duty of the insured in the event that any property of the insured, or for which they are responsible be lost or damaged, to take all reasonable steps to effect its recovery and/or preservation.”

The insurers argued that this clause was a ‘condition’ of the policy and that the obligation upon the insured to take all reasonable precautions for the protection and safeguarding of the goods extended to the taking of all reasonable precautions not to employ dishonest drivers so that the failure to exercise ‘ordinary care’ in selecting staff was a breach of the condition]. Roskill J: ‘There arise two points for decision. First, what is the true construction of this clause and, secondly, once the true construction has been ascertained, has there been any breach of its terms by the assured which would afford the underwriters a defence to the present claim? The first question, to use the language which has been used by counsel in this case, is whether that clause is a condition or a warranty. The use of those two words is not entirely happy because it is well known, particularly in the field of marine insurance law, that the word “warranty” is often used when those who use it in truth mean “condition.” I will, therefore, define what I mean in this judgment by a “condition” and a “warranty.” By a “condition” I mean a contractual term of the policy, any breach of which by the insured will in the event of a loss arising otherwise payable under the policy afford underwriters a defence to any claim irrespective of whether there is any causal connection between the breach of the contractual term and the loss. By “warranty” I mean a contractual term of the policy a breach of which will not of itself afford a defence to underwriters unless there is the necessary causal link between the breach and the loss which is the subject of the claim under the policy. The first question I have to decide is whether this clause is a condition or a warranty. Underwriters contend through Mr Evans, though the contention was not I think very strongly pressed, that this clause is a condition which on its true

construction was broken and therefore in any event underwriters have a defence to the present claim. I therefore turn to consider the true construction of this clause in the context in which it appears and against the background of the policy as a whole… Mr Evans argued that unless one construed clause 9 as a condition, there was only one other clause, namely, that part of clause 10 which I have already read, which was susceptible of being construed as a condition. That may be so, but that of itself seems to me to be no reason for forcing upon clause 9 a construction which it does not otherwise naturally bear. If one looks at the last sentence of clause 9, which is akin to a sue and labour clause in a policy of marine insurance, that sentence is quite plainly not a condition. There is nothing in clause 9 itself to describe it as a condition, and one is therefore left with being invited to construe this clause as a condition when there is nothing on the face of the clause to suggest that it must of necessity be so construed. I therefore see no reason for construing this clause 9 as a condition in the sense in which I have used that term. That point, therefore, fails. I turn next to consider what I think is perhaps the most difficult point in this case. Construing that clause not as a condition but as a warranty, what does it cover? The underwriters say that the words “The insured shall take all reasonable precautions for the protection and safeguarding of the goods and/or merchandise” are not limited to an obligation to take reasonable steps to preserve what I will call the physical safety of the goods, but extend to cover the taking of all possible reasonable precautions such as taking reasonable steps to see that the assured do not employ dishonest servants, for it is argued that if you are careless about the staff whom you engage when those staff are clearly going to be responsible for the transit and safety of the goods in question, then you are not taking all reasonable precautions for the protection and safeguarding

of the goods. That point has force and has been, if I may say so, admirably argued by Mr Evans. If those words at the beginning of clause 9 stood alone, the argument would, I think, have great force. But they have to be construed together with the remaining part of the first sentence and indeed with the second sentence as well. If one reads the clause in this way: “The Insured shall (a) take all reasonable precautions for the protection and safeguarding of the goods and/or merchandise and (b) use such protective appliances as may be specified in the policy and (c) all vehicles and protective devices shall be maintained in good order. Such devices shall be used at all times and shall not be varied or withdrawn without written consent by the underwriters,” the question then arises whether those parts of the clause which I have labelled (b) and (c) operate either to cut down or to influence the language of the opening words of the clause which I have already read… The point is not without difficulty, but I think there is force in Mr Johnson’s arguments, first, that this is a clause for the benefit of the underwriters and, therefore, if underwriters wish to say that it is to extend not merely to what I have called physical precautions but is to cover selection of staff, the clause ought so to state in express terms; and, secondly, that if one looks at this clause as a whole, the impression that it leaves on someone reading it is that it is not intended to cover the whole field but is limited to what, on a reasonable reading of the clause, is that which is mentioned in the clause, namely, the need to protect and safeguard the goods and merchandise. The words in the first part of the clause seem to me to be coloured by the later words in the clause and that to extend this clause so as to impose upon the assured an obligation to vet their staff with due diligence before they take them on is something which the clause does not cover. If underwriters require it, they should say so in express terms. They have not said so in express terms and, therefore, for my part I am not prepared

to stretch the language of this clause in their favour to give it a meaning which in my judgment it does not naturally bear. One has, of course, great sympathy in this case with underwriters who find themselves again and again faced with claims in cases where the assured or their servants have been grossly negligent in the way that loaded lorries have been left unattended and the like. Equally, in the present case one has great sympathy with the assured who are a small firm who had the misfortune to employ a dishonest driver. But questions of sympathy do not enter into this, as Mr Evans rightly stated, one way or the other. This case has to be determined upon the true construction of the clause and upon the application of the facts as I find them to that clause properly construed. If, therefore, that construction be right, as I believe it to be, it is determinative of this case in favour of the plaintiffs.’

Note: The importance of drafting policy terms in unequivocal language so as to accurately reflect the intention of the insurers and the critical distinction between conditions precedent to liability and mere terms which, if broken by the insured only give rise to a claim for damages by the insurers, came to fore in the recent Court of Appeal decision in George Hunt Cranes: [828] George Hunt Cranes Ltd v Scottish Boiler and General Insurance Co Ltd [2002] 1 All ER (Comm) 366 (CA) [The facts appear from Potter LJ’s judgment].

Potter LJ: ‘The defendants had insured a company called Fast Track Projects Limited (“Fast Track”), trading as Bowmech Engineering, under a policy of insurance No 22670628, pursuant to which it agreed to indemnify Fast Track against all sums which it would become legally liable to pay under any contract of hire for compensation in respect of loss or damage to plant hired by Fast Track and continuing hire charges. The claimants had hired the plant to Fast Track in July 1997. On 27 September 1997 the jib and boom of a crane, part of that plant, was damaged whilst in Fast Track’s possession, whereby Fast Track incurred liability to the claimant for £17,248 in respect of repairs to the crane and extended hire charges. The claimant made a written claim to Fast Track dated 30 September 1997, but Fast Track failed to report the claim to the defendants who first learned of the claim some four months later, on receipt of a letter from the claimant direct, dated 23 January 1998. The defendants apparently reacted by writing to Fast Track’s brokers declining liability. On 26 March 1998 Fast Track went into voluntary liquidation. It appears that a claim form completed by Fast Track was first submitted to the defendants on 28 March 1998 but the defendants maintained their attitude. On 29 June 1998 the claimant commenced proceedings against Fast Track in voluntary liquidation, obtaining judgment in default on 15 July 1998 for £21,408.08, inclusive of fixed costs and interest. It is not in dispute that under section 1 of the Third Parties (Rights Against Insurers Act 1930 all of Fast Track’s rights under the defendants’ policy transferred to the claimant. In the preliminary issue heard before the judge the defendants relied on general condition 2(c) of the policy which required delivery of a claim in writing to the insurers within 30 days or such further time as insurers granted in writing. It provided expressly in its last sentence:

“No claim under this policy shall be payable unless the terms of this condition have been complied with.” It is not in dispute that condition 2(c) was not complied with. The issue before the judge was whether compliance with clause 2(c) was a condition precedent to liability under the policy or a mere term of the policy, breach of which would give the defendants the right to counterclaim for damages in respect of any increased expense or other loss incurred by reason of the lateness of the claim. No such counterclaim was advanced. Following a full and careful judgment on the arguments raised before him, which are those which have been recanvassed before us on this appeal, the judge concluded: “The plain wording of this provision…imposes a requirement which must be strictly complied with if any claim is to be paid and…since no claim has been submitted within 30 days or within any additional time allowed by the company there has not been compliance and therefore the defendants are entitled to rely upon the policy condition.” Turning to the detailed terms of the policy, the relevant provisions were those contained in clauses 1 and 2 of the general conditions. Clause 1, headed “Interpretation”, reads as follows: “This Policy and the Schedule shall be read together as one contract. Unless otherwise stated any word or expression to which a specific meaning has been attached shall bear the same meaning wherever it may appear.” Clause 2, headed “Claims Procedure and Requirements”, reads as follows: “Action by the Insured

(a) on the happening of any loss or destruction or damage or any accident or injury which may give rise to a claim the Insured shall give immediate notice thereof in writing to the Company. (b) in respect of loss or destruction or damage caused by malicious persons or by theft it is a condition precedent to any claim that immediate notice of the loss or destruction or damage shall have been given by the Insured to the police authority. (c) the Insured shall within 30 days after such loss, destruction or damage, accident or injury (7 days in the case of loss, destruction or damage caused by riot, civil commotion, strikers, locked out workers or persons taking part in labour disturbances or malicious persons) or such further time as the Company may in writing allow at the expense of the Insured, deliver to the Company a claim in writing containing as particular an account as may be reasonably practicable of the accident injury or any portions of the Plant lost, destroyed or damaged and of the amount of damage thereto together with details of any other insurances on any Plant or property hereby insured. The Insured shall also give to the company all such proofs and information in respect of the claim as may reasonably be required together with (if demanded) a statutory declaration of the truth of the claim and of any matters connected therewith. No claim under this policy shall be payable unless the terms of this condition have been complied with. (d) the Insured shall send to the Company immediately on receipt any letter, writ, summons or other legal process issued or commenced. (e) the Insured shall not negotiate pay, settle, admit or repudiate any claim without the written consent of the Company.”

Before turning to consider in detail the arguments of the parties, I am bound to say that, taken on its own, clause 2(c) appears to state the intention of the parties in the clearest possible terms in its final sentence. The words themselves leave no room for doubt or ambiguity but the intention is that, unless the claim is made and the prescribed information provided within the period specified, then the defendants shall not be liable to pay the claim. However, one must approach the question of construction in the light of paragraphs 19–35 of MacGillivray on Insurance Law, 9th edn… “It is not always easy to decide whether clauses requiring notice of a claim are conditions precedent to the liability of the insurer under the policy, or merely terms of the policy for breach of which the insurer’s only remedy is to claim damages for the extra expense flowing from the insured’s failure to give notice within the proper time. Little more can be said than that it is a matter of construing the policy as a whole.” In this connection it is frequently pointed out that in relation to clauses of this kind, if the contract states that the condition is a “condition precedent” or a “condition of liability”, that is influential but not decisive as to its status, especially when the label condition precedent is attached on an indiscriminate basis for a number of terms of different nature and varying importance in the policy. One may at once observe that that is not the case here. It is also the position that where, in a policy, individual terms are described as conditions precedent, while others are not, the label is more likely to be respected in relation to a clause expressly so identified…However, where one clause is labelled “condition precedent”, and a question arises as to the status of a clause not so labelled, the latter is not, ipso facto, precluded from being regarded as such. If, as in this

case, the wording of the clause is apt to make its intention unambiguously clear, then in my view the absence of the rubric need not be fatal. As with any other contract, the task of construction requires one to construe the policy as a whole. However, in this respect, as it seems to me, if there is a clear expression of intention on the wording of the clause that it shall be treated as a condition precedent, that label or apparent intention cannot simply be ignored. It should at least be regarded as a starting point. I would adopt the further formulation in MacGillivray, 9th edn, 19– 35: “Such clauses should not be treated as a mere formality which is to be evaded at the cost of a false and unnatural construction of the words used in the policy, but should be construed fairly to give effect to the object for which they were inserted, but at the same time so as to protect the assured from being trapped by obscure or ambiguous phraseology.” It seems to me that the wording of the final sentence of clause 2(c) is sufficient to avoid any suggestion that the clause is a trap for the unwary assured. The points made for the claimant before the judge, and repeated before us in favour of the claimant, can be summarised as follows. First, it is said that clause 1 itself is an aid to construction, in that it demonstrates the mutual intention of the parties that there should be consistency in the use of terminology throughout the policy, whether or not the words were specifically defined. In this respect the defendants do not dispute the clear intention of the parties to that end, but submit, as it seems to me correctly, that there is little of assistance to be derived from clause 1 in relation to the task before the court, because the wording of the last sentence in clause 2(c) does not use words which

are identical to, and do not appear to derive any colour from, other terms of the policy. Secondly, it is said that the express provision in clause 2(b) that, in the case of damage caused by malicious damage or theft, it shall be a condition precedent to any claim that notification has been made to the police, which contrasts with the wording of condition 2(c) where there is no use of the expression “condition precedent”, is an indication that the latter shall not be a condition precedent while the former shall. That seems to me to be the strongest point in favour of the assured. However, it seems to me that there are two answers to that submission. First, as already indicated, it seems to me that the language of the last sentence in 2(c) is unambiguously designed to render compliance with the clause a condition precedent to the liability of the defendants. It merely spells out to the assured in plain terms the position imported by the use of the shorthand rubric “condition precedent”. Secondly, it seems to me that, if one looks to the purpose underlying the particular provisions of each part of condition 2, there are more rather than less compelling reasons for regarding clause 2(c) as a condition precedent, than for so regarding 2(b). The purpose behind clauses of the 2(c) type is that the insurer should be properly placed in possession of a notification, with accompanying information, in sufficient time for him to make a reasoned decision, (a) in relation to the existence of cover under the terms of the policy; (b) as to the prima facie amount of the loss; (c), and most important, as to the investigations necessary or advisable to be made while the incident is fresh and evidence still available, whether in the form of an investigation at the accident scene or the availability and memory of potential witnesses. While reports of damage to the police in cases of damage by malicious persons or theft may well assist to that end, in many cases it will do little to assist the insurer in respect of the matters which concern him under 2(c).

Thirdly, it is argued that there is no commercial reason to consider that the parties intended that a breach of clause 2(c) should have any more significant consequence for the insurers than a breach of 2(a), (d) or (e), all of which lack any indication that they are other than ordinary terms rather than conditions precedent. I do not find that argument persuasive. Compliance with general condition 2(c) is plainly of greater importance than compliance with (a), (d) or (e). As for (a), the requirement for immediate notice of a happening which may give rise to a claim is frequently encountered in insurance policies and most unlikely to be regarded as a condition precedent. Its function is to put the insurer on notice that a claim may be coming rather than a necessary indication to him that it is time to investigate, which he will be able to do once he knows that a claim will be made. So far as (d) is concerned, unlike (c) it has nothing to do with notification, assessment or investigation of a claim, delay in which may well prejudice the insurer. It goes to the interests of the insurer in overseeing and/or taking over proceedings at a much later stage. The same is true of (e). The fourth ground of appeal is that the judge below placed undue reliance upon the decision in Welch v Royal Exchange Assurance [1939] 1 KB 294, in which the Court of Appeal was concerned with a clause in a fire policy which, by one of its conditions, provided that, on making a claim, the insured should, inter alia, “give to the corporation all such proofs and information in respect of the claim as may reasonably be required”, and in condition IV included a term identical to the last sentence in clause 2(c) in this case, namely that “no claim under this policy shall be payable unless the terms of this condition shall have been complied with.” By an earlier term of the policy, it was provided that the conditions of the policy were “so far as the nature of them respectively will permit” to be deemed to be conditions precedent to the right of the insured to recover. It was held that condition IV

was a condition precedent to the liability of the insurers and that the failure of the assured to provide information reasonably required in respect of the claim until the hearing of arbitration proceedings relating to it constituted a bar to his claim… On appeal the decision was upheld, MacKinnon and Finlay LJJ holding that, on the true construction of the policy, the requirement rendered the relevant condition a condition precedent with which the insured had not complied…It is contended for the claimant that the decision in Welch is distinguishable, principally upon the ground that there is no equivalent in the policy before this court to the overriding provision in Welch, that the conditions of the policy should “so far as the nature of them respectively will permit be deemed to be conditions precedent to the right of the insured to recover hereunder.” In my view, that particular wording added little to the consideration whether the particular clause to which the court’s attention was directed was or was not to be construed as a condition precedent. For my part, I would also accept, as indeed has been accepted for the defendants on this appeal, that the court should be wary of placing undue reliance on authorities in which similar but not identical provisions have been construed. However, the defendants can derive assistance from Welch, in so far as the Court of Appeal (a) plainly regarded the requirement to provide information, albeit within a reasonable time, as one the nature of which would permit it to be deemed a condition precedent, and (b) expressly declined to equate the word “unless” with the word “until” in the provision equivalent to the last sentence in clause 2(c) in this case. It is also pertinent to note that comparison of the clause in this case with the clause in Welch makes clear the genesis of the wording of clause 2(c) in this policy. Apart from the fact that the final sentence of the clause is identical, it appears that clause 2 in this case is drafted in similarly

incremental form to that adopted in the Welch case, save that clause 2(b) in the instant case, which relates to reporting to the police, has been inserted into the text of what was a single condition in the case of Welch. It thus appears that the draftsman of the defendant’s policy thought it sensible to leave well alone in relation to clause 2(c), having incorporated into it the key words which led the majority of the court in Welch to decide that the condition in that case was indeed a condition precedent. The fifth ground relied on is that the provision in condition 2(c) for the enlargement of the period within which the necessary claim must be made or information provided in some way weakens the interpretation of the final sentence as demonstrating an intention to render 2(c) a condition precedent. I do not accept that submission. As it seems to me, the recognition that the insurer may extend the period is really no more than recognition of his right to waive strict compliance with the period imposed in any situation where it seems to him reasonable to do so. Grounds 7 and 8 assert that condition 2(c) is not a condition precedent to liability but an innominate term which is apt only to create a defence to a claim under the policy if the consequences of breach are so serious as to give the insurers a right to reject the claim (see Alfred McAlpine plc v BAI (Run-Off) Ltd [above, [823]]). It is said that the condition is perfectly workable as an innominate condition. It does not seem to me that this submission carries the matter very much further. The defendants accept that, if the clause is not to be regarded as a condition precedent, it would indeed be an innominate term. However, the Alfred McAlpine case concerned the construction of a condition which did not on its face indicate the consequence of a failure to comply and was not directly concerned with the question whether a clause, plainly drafted so as to have the effect of a condition precedent, should be otherwise construed…

Finally, it is argued that the provision in condition 2(c) to the effect that any extension of time would be at the expense of the insured, is indicative that the term should indeed be construed as an innominate term, recognising, as it does, that any risk of increased difficulties in investigation for the defendant insurers can be adequately compensated for by a payment in respect of any increase in the insurer’s costs of investigation. The defendants, on the other hand, argue the opposite, ie that the claim is recognizing the principle of prejudice to the insurer in his investigation and conferring upon the insurer the right himself to permit to the insured an extension of time in a situation where the only prejudice to be anticipated is an increase of expense to the insurer. In my view, the defendants are correct. The clause is aimed at imposing compliance with time limit provided as a condition precedent unless, at the insurer’s option, it is extended for such further time as the company may in writing allow, the provision as to payment of any extra expense being tacked on as an additional protection for the insurer. For all the reasons which I have given above, I would confirm the decision of the judge and dismiss the appeal.’

8.6.2 Breach of Condition and Waiver As has been seen, the decisions in The Good Luck and HIH Casualty and General Insurance Ltd v AXA Corporate Solutions (above, [819] and [820] respectively) show that waiver has an extremely limited application in cases involving breach of promissory warranty which, as Lord Goff has explained, gives rise to automatic discharge of the insurer’s liability. However, where a breach of condition is alleged we are concerned with avoidance

of a particular claim or avoidance of further liability and in this context the conduct of an insurer may be such as to give rise to waiver. [829] Evans v Employers Mutual Insurance Association Ltd [1936] 1 KB 505 (CA) [In the proposal form for motor insurance the insured stated that he had held a driving licence and had had practical experience of driving for five years. This was untrue. When he made a claim in respect of an accident that resulted in damage to the car and injuries to third parties, he stated on the claims form that he had been driving for six weeks. The claims form together with the original proposal form were passed to a clerk for checking. The clerk noticed the discrepancy but did not consider it to be of importance. The insurers paid part of the claim and took over the negotiation of the claims by third parties. At this point the claims superintendent spotted the discrepancy and the insurers repudiated liability. In arbitration proceedings it was held that the insurers were not entitled to repudiate liability given that the claims clerk knew of the discrepancy and the insurers, having met part of the claim, took over the right of handling the third-party claims]. Greer LJ: ‘The umpire decided that the Association could not repudiate their liability under the policy after having received the information they received through their agents, Anderson, Morice and Mitchell, and notwithstanding that information paid the claimant and taken to themselves the

right of dealing with the third party claim. The umpire does not use the word “waiver,” but I think his decision amounts to a decision that by their conduct the Association affirmed the policy after notice of the facts which entitled them to repudiate, and thereby waived their right to repudiate liability under the policy. The question he states for the Court is whether his decision is correct, which necessarily means correct in law. In my judgment it is correct, or to put it the other way, it is not wrong in law, for two reasons. First, I think the knowledge of Mitchell, to whom in the ordinary course of their business the Association entrusted the duty of comparing the claim form with the proposal form so as to ascertain whether there was any discrepancy between them, fixes the Association with the knowledge of that which came to the knowledge of Mitchell. Secondly, I think the award of the umpire was right because the Association are not entitled in law to say that they were not aware of the contents of documents such as the proposal form and the claim form, which at their request the claimant addressed to them. They must be treated as having received the information contained in these two documents, and they cannot be heard to say that they did not know their contents…’

8.7 Reform As seen in relation to non-disclosure and misrepresentation, calls for reforming insurance law span some fifty years and the issue of insurance contract terms, particularly the ‘basis of the contract’ clause, has received considerable attention. However, insurers have successfully prevented legislative intervention by opting for self-regulation

(see the Statement of General Insurance Practice and the Statement of Long Term Insurance Practice, above [808] and [809], respectively; and see ADM Forte, “The revised statements of insurance practice: cosmetic change or major surgery” [1986] MLR 754 (see chapter 4, [435]). Yet, notwithstanding the Statements of Practice, the National Consumer Council in 1997 (see below, [835]) called for the statutory prohibition of basis of contract clauses. Given the weight of opinion calling for reform the lack of legislative response is lamentable. [830] Law Reform Committee Fifth Report, Conditions and Exceptions in Insurance Policies, Cmnd 62 (London, HMSO, 1957) ‘3. We conceive that our primary duty under our terms of reference is to summarise the practical effects, as we understand them, of the matters referred to on the liability of insurers, this we have attempted in paragraphs 4 to 10 below. We assume, however, that there is further implied an invitation to indicate whether the situation disclosed is in our opinion such as to justify, or require, amending legislation, our views on this question are contained in paragraphs 11 to 14. At an early stage we decided to exclude marine insurance from the scope of our enquiry. The general public is not interested in marine insurance and we have no reason to believe that the business circles who are concerned with the subject are in any way dissatisfied with the law as it stands… 5. The other factors affecting the liability of insurers which we have considered arise from express terms and conditions in common use in proposal forms and

insurance policies. These may be grouped in four classes (i) questions and answers in proposal forms (ii) promissory warranties relating to the risk (iii) clauses requiring the insured to do certain things after a loss has occurred ; (iv) arbitration clauses. We consider the effect of these factors in that order in the paragraphs which follow. 6. In certain classes of insurance, a proposer is required to answer detailed and specific questions relating’ to the risk to be insured. In life and motor vehicle insurance this practice may he regarded as invariable; in fire insurance, we understand that it is unusual, in other classes the practice probably varies. Where such questions are asked, it is usual for the proposal form to contain a clause whereby the proposer agrees that the truth of his answers shall be the basis of the contract. The balance of authority on the construction of such clauses is overwhelmingly in favour of interpreting “truth” to mean “accuracy”. The result of the presence of such a clause in a proposal form is therefore to render irrelevant any question either of the materiality of the information so obtained, or of the honesty or care with which it was given. If the answer given was inaccurate the insurers are at liberty to repudiate. Further, we think that it is clear that, as a matter of law, the answering of specific questions, however detailed and searching, does not relieve the proposer from his duty to, disclose material facts, although in practice, especially in life insurance, the exhaustive nature of the inquiry may be such as to make it highly improbable that any possible material fact will not be covered… 8. The effect of any promissory undertaking by the insured relating to the risk (in the law of insurance, contrary to general usage, always called a warranty) is perfectly

clear. Ever since the time of Lord Mansfield it has been consistently held that warranties must be strictly and literally complied with, and that any breach entitles the insurer to repudiate. The result may be very serious for the insured, since the breach on which the insurers rely may have been quite unconnected with the loss. In this context we would refer briefly to the authorities which show that in any particular case it may be very difficult for the court to discover, from the wording of the proposal form or policy, whether the form of words used should be construed as (a) a statement of present fact or intention, (b) a promissory warranty, or (c) a description of the risk. The solution may well be decisive, since in case (a), if the statement was true at the time it was made, the insured is covered, in case (b) any departure, whether at the time of loss or not, entitles the insurers to repudiate, and in case (c) the insured is covered if the state of affairs described obtained at the time of the loss, irrespective of whether there had been any departure from it earlier. 9. The effect of conditions relating to things to be done by the insured after the occurrence of a loss differs according to whether they are interpreted as conditions precedent to the liability of the insurers, or merely as collateral undertakings the breach of which gives rise to a claim for damages. The answer depends on the construction of the individual condition, but the general tendency has been reconstrue them as conditions precedent. The presence of such clauses is a very valuable protection to the insurers, since their function is usually to facilitate prompt investigation after a loss, to ensure control by the insurers of any litigation or negotiations with third parties, or to protect their interest in matters of salvage or subrogation. They are not, we think, normally calculated to be prejudicial to an insured who takes the trouble to read his policy, except

perhaps the condition, common in certain types of policy, which requires notice of loss to be given within so many days. Circumstances may arise, examples of which were brought to our notice, which render compliance with such a condition impossible. For example, where the discovery of one irregularity on the part of an employee leads to the discovery of a series of embezzlements in the past, the presence of such a clause in a fidelity policy taken out to insure against such losses will entitle the insurers to refuse compensation for any of the losses except the last… 11. It appeared to us that such a state of the law, combined with the prevalence of such terms and conditions in insurance policies as we have described in the preceding paragraphs, is capable of leading to abuse, in the sense that a variety of circumstances may entitle insurers, after a loss has occurred, to repudiate liability as against an honest and at least reasonably careful insured. Material was available to us, in the form both of reported cases and of instances within the experience of those who supplied us with information, which showed that such abuses had in fact sometimes occurred. It was forcefully represented to us by those representatives of insurance interests who submitted memoranda or gave oral evidence that no reputable insurer would rely on a purely technical defence to defeat an honest claim. This may well be true, and we think that in general it is true, but it does not alter the fact that the ease with which a technical defence may be found means that in many cases an insurer is in a position to substitute his own judgment of the claimant’s bona fides for that of a court. 12. It does not, however, seem to us that the mere fact that a branch of the law is theoretically open to criticism or even that it is susceptible of abuse in itself justifies a positive recommendation that it should be amended.

Most of the situations, potentially prejudicial to the interests of the insured, to which we have drawn attention, are the product of express contractual stipulations rather than of rules of law in the ordinary sense; any proposal to alleviate such situations in the interest of the insured would involve interference with the liberty of contract of the insurer. The desirability or otherwise of such legislation seems to us a broad question of social policy outside our competence. We do not therefore set out here the reasons given to us by the representatives of the insurance interests for the insertion of provisions of this kind in contracts of insurance or their views as to the likely consequences of the omission of such provisions. Were there evidence sufficient to justify the conclusion that insurers abuse their undoubtedly powerful legal position to any substantial extent, the position might be different, but the evidence we have received falls far short of that… 14. While it is not for us to determine whether legislation is desirable, we think that we can properly consider to what extent it is practicable to introduce any new provisions into existing insurance law and what form such provisions should take. We think that any or all of the following provisions could be introduced into the law and that no legal difficulties would arise in their application (1) that for the purposes of any contract of insurance no fact should be deemed material unless it would have been considered material by a reasonable insured (see chapter 4); (2) that, notwithstanding anything contained or incorporated in a contract of insurance, no defence to a claim thereunder should be maintainable by reason of any misstatement of fact by the insured, where the insured can prove that the statement was true to the best of his knowledge and belief…’

[831] Law Commission Report No 104, Insurance Law — Non-Disclosure and Breach of Warranty, Cmnd 8064 (London, HMSO, 1980) ‘WARRANTIES

Defects in the present law 6.9 Later we set out our view on the defects in the rules of law which give insurers the right to create warranties as to past or present fact by means of ‘basis of the contract` clauses. There are however in our view four major defects in the present law of warranties which derive from the characteristics of warranties and the ways in which they are created: (a) it seems quite wrong that an insurer should be entitled to demand strict compliance with a warranty which is not material to the risk and to repudiate the policy for a breach of it; (b) similarly it seems unjust that an insurer should be entitled to reject a claim for any breach of even a material warranty, no matter how irrelevant the breach may be to the loss; (c) material warranties are of such importance to the insured that in our view he ought to be able to refer to a written document in which they are contained; (d) as we have already mentioned, we deal below with the mischiefs which arise from the creation of warranties by the use of a “basis of the contract” clause in a proposal form. Is reform of the law necessary? 6.10 In our view the defects in the present law just described show a formidable case for reform…

Reform of the law of warranties

Introduction 6.11…warranties are of two types: warranties as to past or present fact, and promissory warranties. In view of the recommendations which we make as regards “basis of the contract” clauses insurers wishing to introduce warranties of the first type will no longer be able to do so either by the use of appropriate words in a proposal form or by a provision which refers to a proposal form. Insurers will have to introduce them individually in compliance with the formal requirements set out in paras 6.14 and 7.10…However, we anticipate that as a matter of underwriting practice insurers will find it necessary to introduce such warranties in relatively few cases, usually in relation to large commercial risks and normally as a result of negotiations with the insured. Thus, although the recommendations in this part are intended to apply both to warranties as to past or present fact and to promissory warranties, they will be applicable in the main to promissory warranties.

A modified system of warranties 6.12 In our view, the system of warranties in English insurance law should be modified to the extent necessary to eradicate the defects we have described. The first defect in the present law noted above was that a breach of any warranty entitles the insurer to repudiate the policy whether or not the warranty was material to the risk. We consider that insurers should not be entitled to repudiate the policy for the breach of an undertaking which is immaterial to the risk, even if the word ‘warranty is used or if the true construction of the contract provides the insurer with the right to repudiate for any breach of warranty even if immaterial. Accordingly, we recommend that a term of the

contract should only be capable of constituting a warranty if it is material to the risk, in the sense that it is an undertaking relating to a matter which would influence a prudent insurer in deciding whether to accept the risk and, if he decides to accept it, at what premium and on what terms. 6.13…We…consider that if the insurer has complied with the formal requirements recommended in the next paragraph, so that the insured is made aware of his obligations, but the insured none the less acts in breach of any such obligation, it is inappropriate that the insurer should also have to prove the materiality of the obligation to the risk as a condition of being entitled to avoid the policy. We accordingly recommend that there should be a presumption that a provision in a contract of insurance, which possesses the attributes of a warranty at common law, is material to the risk. The insured can rebut this presumption by showing that the provision in question relates to a matter which would not have influenced the judgment of a prudent insurer in assessing the risk. It is to be noted that this recommendation is along the same lines as that made in relation to the materiality of questions in proposal forms. 6.14 It will be convenient to discuss next the third of the defects relating to warranties which we noted in para 6.9. This concerns the desirability of the insured being able to refer to a written document containing the warranties by which he is bound. In our view the insurer should be obliged, as a condition precedent to the legal effectiveness of the warranty, to furnish the insured with such a document at least as soon as practicable after the insured gave the warranty in question. If the insured has completed a proposal form and has given answers to certain questions relating to the future, these answers will often have the force of promissory warranties because of the inclusion of a “basis of the contract” clause. The insurer would accordingly

be able to comply with this obligation by furnishing the insured with a copy of the completed proposal form. Where no proposal form has been completed, and the insured has given a promissory warranty, we consider that it should be incorporated as an individual term on the face of the policy or in an endorsement thereon. However, we are aware that in some cases, for example where short term cover is granted. no policy is ever issued and that in others, for example where provisional cover is granted, a policy may not be issued within a reasonable time of the warranty having been given. In the case of provisional cover, a warranty may often be given over the telephone. In all such cases the insurer should be required to confirm in writing the warranty given by the insured as soon as is practicable in the circumstances. This may be done in a cover note, in a certificate of insurance or even by letter. If the insurer fails to comply with these formal requirements he should in our view be precluded from relying on a breach of the warranty in question in order to repudiate the policy or reject a claim. Nevertheless, if a loss should occur in the interim, before it has become practicable for the insurer to provide such written confirmation, then the insurer should be entitled to rely on an oral warranty as this will then still be fresh in the mind of the insured. The legal effect of a breach of warranty 6.15…One of the mischiefs in the present law of warranties to which we have drawn attention is that insurers are…able to base their refusal to pay a claim on a breach of warranty which may be totally unconnected with the loss. We are told that insurers usually only make use of this type of “technical repudiation” if they suspect but are unable to prove some other ground for repudiation. In our working paper our provisional view was that an insurer should not be entitled to reject the claim unless he is able to prove a valid ground

for rejection. Our provisional recommendation was that the insurer’s right to reject a claim for a loss occurring after the date of the breach should be restricted. 6.16 On consultation, it was put to us that such a restriction would result in the erosion of safety standards by removing or reducing the incentive for compliance with warranties many of which are in the nature of undertakings on the part of the insured to observe precautions. We think it unlikely that a restriction of the insurer’s rights of rejection would remove or reduce the incentive to comply with warranties: it may well be that many insureds observe prescribed precautions not out of any considerations relevant to their rights against the insurers but simply because they wish to preserve their persons or property from loss or damage. 6.17 On consultation the majority of those who commented agreed that the insurers’ rights to reject claims should be restricted but some of them raised minor points as to how the restriction proposed in the working paper would work in practice. In order to meet these points, we have attempted, in the following paragraphs, to improve our formulation…

Our recommendation 6.22 Our recommendation is that in cases of breach of warranty the insurer should prima facie be entitled to reject claims in all cases which occur after the breach provided that the formal requirements enumerated in para 6.14 have been complied with. However, if the insured can show either: (a) that the broken warranty was intended to reduce (or prevent from increasing) the risk that a particular type

of loss would occur and the loss which in fact occurs is of a different type; or (b) that even though the loss was of a type which the broken warranty was intended to make less likely, the insured’s breach could not have increased the risk that the loss would occur in the way in which it did in fact occur, then the insured should be entitled to recover; but in such cases the insurer should remain entitled to repudiate the policy for the future on account of the breach of warranty which has occurred. The reason for the latter qualification is that in our view insurers should not be compelled to continue to cover insureds who have committed breaches of warranty; they should remain liable for prior claims on the basis of the nexus test referred to above, but subject to this they should be entitled to discontinue to cover… “BASIS OF THE CONTRACT” CLAUSES

The present law 7.1 We have seen that an insurer may avoid a contract of insurance for the nondisclosure of a material fact. However, insurers often pre-empt the issue whether a particular fact is material by including in the proposal form a declaration for signature by the proposer whereby he warrants the accuracy of all the answers to the questions asked: the usual formula is to provide that the proposer’s answers are to form the “basis of the contract” between the insurer and the insured…Since, in cases where the answer related to past or present facts, the breach of warranty is committed at the moment when the contract is made, the effect is that the insurer may refuse to pay any claims under the policy. The fact that the insured may have answered the questions

in good faith and to the best of his knowledge and belief does not help him if his answers are in fact inaccurate… REFORM OF THE PRESENT LAW

The mischief 7.5 It is clear…that “basis of the contract” clauses constitute a major mischief in the present law. These clauses, to the extent that they apply to statements of past or present fact in proposal forms, seem to us to be objectionable on three main grounds. First, they enable insurers to repudiate the policy for inaccurate statements even though they are not material to the risk. Secondly, they entitle insurers to repudiate the policy for objectively inaccurate statements of fact even though the insured could not reasonably be expected either to know or to have the means of knowing the true facts. Thirdly, the elevation en bloc of all such statements into warranties binding on the insured means that, if the insurers can establish any inaccuracy, however trivial, in any of the statements, they can exercise their right to repudiate the policy, even when the statement is not material to the risk and even when it concerned matters beyond the insured’s knowledge of means of knowledge. Such a repudiation is often referred to as one example of a “technical” repudiation. 7.6 Insurers contend (and indeed one sector of the insurance industry mentioned this on consultation) that in practice they only take advantage of technical defences, such as those founded on “basis of the contract” clauses, to repudiate policies when they suspect fraud which they are unable to prove. However, we reiterate the view taken in the working paper that it is unsatisfactory for insurers to be able to repudiate policies on mere suspicion of fraud. It should be for the courts, and only for the courts, to make findings of

fraud. It seems quite unacceptable that insurers should in effect in many cases have a discretion to repudiate policies on technical grounds; their entitlement in this regard should depend on the law and not on their discretion. 7.7 The first of the above objections to “basis of the contract” clauses has already been met by our recommendation that no provision of a contract of insurance should be capable of constituting a warranty unless it relates to a matter which is material to the risk. This of itself does not however go far enough, since it does not meet the second and third objections made in para. 7.5. Earlier in this report, we pointed out that it was unjust to the insured to require him, by means of a proposal form, to give objectively accurate answers to specific questions as to past and present facts which were outside his knowledge or means of knowledge. We accordingly reached the conclusion that such injustice could best be avoided by a provision that the insured should be treated as having discharged his duty of disclosure if he has answered any such questions to the best of his knowledge and belief, after making such enquiries as are reasonable, having regard both to the topics covered by the question and the nature and extent of the cover which is sought, even if his answer is in fact inaccurate. In our view it would be unacceptable if insurers were able to circumvent the protection thus afforded to the insured by obtaining from him, by way of a “basis of the contract” clause, a warranty as to the accuracy of all or any of his answers. The Law Reform Committee undoubtedly had this mischief in mind when it suggested that a provision could be introduced into our law without difficulty whereby: “Notwithstanding anything contained or incorporated in a contract of insurance, no defence to a claim thereunder should be maintained by reason of any misstatement of fact

by the insured, where the insured can prove that the statement was true to the best of his knowledge and belief.” 7.8 Accordingly, our recommendation is that any “basis of the contract” clause should be ineffective to the extent that it purports to convert into a warranty any statement or statements by the insured as to the existence of past or present facts, whether the insured’s statement is contained in a proposal form or elsewhere. However, it would defeat our recommendations if insurers were able to evade this ban on “basis of the contract” clauses by obtaining from the insured a separate warranty as to past or present fact or a series of such warranties, either in proposal forms or in documents which refer to proposal forms. We therefore recommend that no provision in a proposal form whereby the insured promises that a state of affairs exists or has existed should be capable of constituting a warranty. This would mean, for instance, that a promise by the insured in a proposal form that his house is constructed of brick and slate would not constitute a warranty. Furthermore, any provision either in or referring to the proposal form whereby the insured purports to undertake the accuracy of a statement or statements in the proposal form concerning past or present fact should be ineffective to create a warranty. This would mean for example that a provision of the policy whereby the insured declares that answers to specific questions in the proposal form are true would not constitute a warranty. 7.9 The object of these recommendations is twofold. The first is to deny any legal efficacy to the “basis of the contract” clause as regards warranties as to past or present facts. The second is to prevent the proposal form from being used as a vehicle for the creation of warranties as to past or present facts and to ensure that the parties’ rights and duties as regards statements made by the insured in the proposal form as to past or present fact are governed

exclusively by the recommendations we have made in Pt IV of this report.

Effect of our recommendation 7.10 We should, however, make it clear that we do not intend to ban specific undertakings by the insured as to the existence of past or present facts or to prevent such specific undertakings from constituting warranties in all cases. If insurers consider it necessary to obtain such undertakings, they should be able to do so by introducing them into the policy as individual specific warranties, always provided, however, that the formal requirements which we have recommended in regard to the creation of warranties are satisfied. Furthermore, we should point out that our other recommendations concerning warranties substantially restrict the present rights of insurers to reject claims for breach of a warranty. 7.11 We turn next to promissory warranties. If an answer in a proposal form relates to the future, then under the present law a “basis of the contract” clause will elevate that statement into a promissory warranty. We do not see the same objection to this as in relation to statements as to past or present fact because the safeguards and precautions which can be created by promissory warranties are clearly necessary for insurers and unobjectionable, and there appears to be no reason to prevent their creation by means of “basis of the contract” clauses as a matter of convenience. There is then the further possibility that, as noted above, an answer in a proposal form may relate to past and present fact as well as containing a reference to the future. In such cases a “basis of the contract” clause will be effective under out recommendations only insofar as it creates a promissory warranty, and we consider this to be unexceptionable for the reasons stated above. Accordingly,

we recommend that no change be made to this aspect of the present law…’

[NB reference by the Law Commission to the remedy of repudiation must now be read in the light of the decision of the House of Lords in The Good Luck (above, [819]). ‘DRAFT BILL Clause 8 [warranties] (1) A provision of a relevant contract of insurance whereby the insured: (a) affirms or denies the existence of, or gives his opinion with respect to, any fact or state of affairs at any time (whether past, present or future); or (b) undertakes that any particular state of affairs will continue or that a particular course of action will or will not be taken, shall not be capable of constituting a warranty unless it relates to a matter which is material. (2) An insurer shall not be entitled to rely for any purpose on a breach of warranty in a relevant contract of insurance unless, at or before the time the contract was entered into or as soon thereafter as was practicable in the circumstances of the case, a written statement of the provision which constitutes the warranty was supplied to the insured. (3) If the insurer under a relevant contract of insurance seeks for any purpose to rely on a breach of a provision of the contract as a breach of warranty then, unless the contrary is proved, that provision shall be presumed to be material. Clause 9 [basis of contract clauses]

(1) Without prejudice to section 8 above, if, in connection with a relevant contract of insurance the insured makes a statement affirming or denying the existence of. or giving his opinion with respect to, any fact or state of affairs at any time past or present, that statement: (a) shall not be capable of constituting a warranty if it is contained in. or is made by reference to any provision of, a proposal form; and (b) shall not be capable of being converted into a warranty by means of any provision purporting to incorporate it into the contract, either alone or together with other statements (and whether by declaring the statement to form the basis of the contract or otherwise). (2) Nothing in the section relates to promissory warranties, that is to say, warranties consisting of undertakings such as are mentioned in s 8(1)(b) above and warranties relating to any fact or state of affairs which may or may not come into existence at a future time. Clause 10 [consequences of a breach of warranty; see now The Good Luck [above, [819]]] (1) If an insurer seeks to avoid a relevant contract of insurance in reliance on a breach of warranty, the repudiation shall not be effective with respect to any time prior to the date on which notice in writing of the repudiation is served on the insured. (2) The following provisions of this section apply where: (a) the insured under a relevant contract of insurance is in breach of a warranty in that contract; and (b) after the date of the breach an event occurs which gives rise to a claim under the contract. (3) If, in a case falling within sub-section (2) above: (a) the insurer seeks to avoid the contract in reliance on the breach; but

(b) by virtue of sub-section (1) above, the effective date of the repudiation is after the date of the event which gives rise to the claim, then, notwithstanding that the relevant contract of insurance continues in force until the date of the service of the notice of repudiation, the insurer shall not be liable to meet the claim unless the case falls within sub-section (5) below. (4) If, in a case falling within sub-section (2) above, the insurer: (a) does not seek to avoid the contract as mentioned in sub-section (3) above; but (b) seeks to reject the claim by notice given to the insured; the contract of insurance shall continue in force but the insurer shall not be liable to meet the claim unless the case falls within sub-section (5) below. (5) In a case to which sub-section (3) or sub-section (4) above applies the insurer shall be liable to meet the claim if the insured proves either: (a) that the warranty concerned was intended to safeguard against, or was otherwise related to, the risk of the occurrence of events of a description which does not include the event which gave rise to the claim; or (b) that the breach of warranty could not have increased the risk that the event which gave rise to the claim would occur in the way in which it did in fact occur.’

Note: While direct statutory intervention along the lines of the Law Commission’s Draft Bill is still awaited in the UK other jurisdictions, for example Australia and a number of North American states, have not been so slow in legislating against basis of the contract

clauses. In effect this has been achieved by providing that answers to questions in proposal forms shall be deemed to be representations. [832] (Australian) Insurance Contracts Act 1984 (as amended) 24 Warranties of Existing Facts to be representations A statement made in or in connection with a contract of insurance, being a statement made by or attributable to the insured, with respect to the existence of a state of affairs does not have effect as a warranty but has effect as though it were a statement made to the insurer by the insured during the negotiations for the contract…

[the effect of section 24 is that the insurer only has recourse to the remedies set out in sections 28–30 of the Act (see chapter 4). [833] Florida Statutes (1993) § 627.409 Representations in applications; warranties …A breach or violation by the insured of any warranty, condition, or provision of any wet marine or transportation insurance policy, contract of insurance, endorsement, or application therefore does not void the policy or contract, or constitute a defense to a loss thereon, unless such breach or violation increased the hazard by any means within the control of the insured.

[834] Virginia Code Annotated (1993) § 38.2–309. When answers or statements of applicant not to bar recovery on policy.

All statements, declarations and descriptions in any application for a policy of insurance or for the reinstatement thereof shall be deemed representations and not warranties, and no statement in such application or in any affidavit made before or after loss under the policy shall bar a recovery upon a policy of insurance, or be construed as a warranty, anything in the policy to the contrary notwithstanding, unless it be clearly proved that such answer or statement was material to the risk when assumed and was untrue.

§ 38.2–315. Intervening breach. If any breach of warranty or condition in any insurance contract covering property located in this State occurs prior to a loss under the contract, such breach shall not avoid the contract nor permit the insurance company to avoid liability unless the breach existed at the time of the loss.

Note: Calls for reform in the UK continue unabated and in 1997 the NCC again pressed for implementation of the Law Commission’s Draft Bill or reform along the lines of the Australian statute. [835] Insurance Law Reform — The consumer case for a review of insurance law (London, NCC 1997) ‘4.5 “Basis of the contract” clauses These clauses — giving an insurer an absolute right to repudiate a policy completely on the grounds, for instance, of an immaterial inaccuracy on a proposal form — are

notoriously unfair, as the bulk of the industry recognises. Although little used today, the clause can still crop up on the proposal forms of insurers that do not subscribe to the Association of British Insurers’ code of practice. The only solution to their continuing use is to outlaw them altogether, as the UK’s Law Commission recommended in 1980 and as the 1984 Australian legislation has already done.’ ‘Recommendation 7 We recommend a legal prohibition on “basis of the contract” clauses.

Policy terms and conditions …there seems no reason why insurers should be able to rely on breaches of warranties or conditions precedent where the policy holder’s loss is not related to the breach, as the British industry’s statement of practice recognises. This needs to be put into full legal effect, to cover those insurers not bound by the voluntary statement. At the same time, there seems no justification for allowing an insurer to repudiate a claim for breach of a subsidiary term when it has not been prejudiced by the breach. Insurers will be adequately protected if they can counter-claim for any loss they have suffered as a result of the breach… Recommendation 8 We recommend reform of the law to restrict the insurer’s right to deny a claim on the grounds that the policy has been breached because of some act or omission of the insured or some other person: (a) where conduct cannot cause a loss, the insurer cannot refuse to pay the claim; subject to the insurer’s right to claim damages for any loss they can prove they have suffered. (b) where the policy holder’s act or omission was reasonably capable of causing or contributing to the loss, the

insurer may refuse to pay the claim unless one of the following three qualifications applies: (i) if the policy holder can prove that no part of the loss was actually caused by his act or omission, the insurer cannot refuse to pay the claim, (ii) if (i) applies in relation to a part of the loss, the insured can recover for that part, (iii) if the act or omission was necessary to protect the safety of a person or to preserve property or where compliance with the policy was not reasonably possible, the insured may recover. Two types of contractual term are causing special problems to consumers — and we single them out for blanket prohibition. The first are terms that oblige policyholder, in any dispute about the liability or the amount of a claim to the dispute to arbitration. Mandatory arbitration clauses are already banned in other types of consumer contract. We believe the same apply in insurance contracts. The second are terms that appear in payment protection policies, excluding or limiting the policyholder’s cover if it transpires that he or she had a pre-existing health problem — a term that applies even if the policy holder could not possibly have known about the when taking out the policy. Recommendation 9 We recommend law reform to make the following terms void: (a) mandatory arbitration for disputes about liability or amount of a claim; (b) exclusions from, or limitations on, cover in respect of sickness or disability (for insurance of a person) or in respect of pre-existing defects or imperfections (for insurance of a thing) of which the insured was reasonably unaware at the time of entry into the contract.’

Note:

Despite the failure of the UK legislature to respond to the various calls for reforming insurance warranties and conditions, such terms are now caught by the Unfair Terms in Consumer Contracts Regulations 1999 ((SI 1999 No 2083), (replacing with some modifications the Unfair Terms in Consumer Contracts Regulations 1994 (SI 19994 No 3159)), which give some protection to the ‘consumer’ insured. However, doubts have been expressed concerning the scope of the Regulations in this regard. A term that is drafted in ‘plain, intelligible language’ and which relates to the main subject matter of the contract is not subject to the assessment of fairness (reg 6(2)(a)). An insurance warranty may therefore fall outside the reach of the Regulations. (see Adams, [2000] JBL 203, below [837]; cf Bankers Insurance Co Ltd v South [2003] EWHC 380, below [838]). [836] JE Adams, “Basis of the Contract Clauses and the Consumer” [2000] JBL 203 ‘The European Directive and the Regulations Industry lobbying, however, failed to gain comparable exemption from the European Directive on Unfair Terms [[1993] OJ L95/29; Dir 93/13] and the industry had to be content with a partial exemption. The relevant paragraph of the preamble to the Directive makes this quite clear — “assessment of unfair character shall not be made of terms which describe the main subject matter of the contract nor the quality/price ratio of the goods or services supplied… whereas it follows, inter alia, that, in insurance contracts, the terms that clearly define or circumscribe the insured risk and the insurer’s liability shall not be subject to such

assessment since these restrictions are taken into account in calculating the premium paid by the consumer” and effect was given to Article 4.2 of the Directive by the Unfair Terms in Consumer Contract Regulations 1994. From 1 October 1999 they have been replaced by the 1999 Regulations, and the following discussion cites the new Regulations, and indicates the earlier replaced Regulation. Before discussing that, and the remainder of the Regulations relevant to this article, some general points should be made. First, and the most obvious distinction, the Regulations are law and the Statements of Practice are not, although routinely applied by the Ombudsman. Secondly, the Regulations apply to a consumer as defined by Regulation 2(1) to be “a natural person…acting for purposes which are outside his trade, business or profession.” The Statements apply to “policyholders…insured in their private capacity only”; they must also be “resident in the UK” (whether at inception/ renewal or at claim, or both, is not entirely clear) which does not apply the Regulations although obviously English law must be the governing law. The problems of differing criteria in various “consumer” statutes are notorious. The Director General of Fair Trading has a duty, under Regulation 10(1) (ex 8(1)), “to consider any complaint made to him that any contract term drawn up for general use is unfair” and can ultimately apply for an injunction against those using or recommending use of offending clauses. As has been seen, not only does the A.B.I. not have such an express specific duty, but it appears unwilling to employ its more general powers to secure compliance. The Regulations only apply to terms “not individually negotiated”, but, in strict theory, there is no such restraint on matters dealt with in the Statements. Lastly, the Regulations apply to all sellers and suppliers, as defined in Regulation 2(1), whereas the Statements only apply directly to A.B.I. members, indirectly, through Ombudsman machinery, to Lloyd’s and even more indirectly

and somewhat vaguely to authorised insurers if the D.T.I. does indeed require them to follow the spirit of the Statements.

The Exemption Under Regulation 6(2) (ex 3 (2)), “the assessment of the fairness of any term shall not relate (a) to the definition of the main subject-matter of the contract, or (b) to the adequacy of the price or remuneration…” This is subject to the condition “it is in plain intelligible language”, a concept to be discussed later. In discussing both this sub-regulation and the provision of the Directive from which it is derived, a convenient shorthand has been, across the board and not only in the context of insurance, to refer to them as “core conditions”. If that were an accurate classification what could be more core-like than the statements, however intrinsically trivial, declared to be the basis of the contract? However, despite the juridical significance of warranties in insurance, there can be no question of Regulation 6(2) applying by the mere application of the deeming basis of contact device. Regulation 5 (ex 3 and 4) So, the acceptability of the alchemical four words depends on Regulation 5(1) (ex 4(1)) which makes a term unfair which “contrary to the requirement of good faith causes a significant imbalance to the parties’ rights and obligations under the contract to the detriment of the consumer.” Assessment under the 1994 Regulations had to take into account the matters specified in Regulation 4(2) and, by virtue of 4(3), the Second Schedule. Regulation 4(2) has become 6(1) in the 1999 Regulations but the Second Schedule has gone altogether. Given the judicial and academic criticisms [of basis of the contract clauses], and

indeed the promulgation of the Statements of Practice themselves, there can surely be no doubt at all that the Regulation 5(1) criterion is fully met. So the unfair term will not bind a consumer.

The category of unfairness Regulation 5(5) (ex. 4(4)) invokes the indicative and nonexhaustive list of the terms (set out in the Second Schedule ex. Third Schedule), which may be regarded as unfair. At first glance, basis of the contract provisions do not easily fit into any of the 17 categories but the list, it must be remembered, is non-exhaustive and it is the thrust of this article that the provisions are manifestly unfair. Moreover, Regulation 7(1) (ex 6) obliges the seller or supplier to ensure that any written term of a contract is expressed in plain, intelligible language. This is a novel test in English law and its ramifications are only slowly being worked out. Two points must be made, namely that no sanction is expressly attached to breach of the duty and secondly that it is not entirely clear whether the criteria are to be judged objectively or by reference to the specific aggrieved consumer. As to the first point, breach of the duty must surely be a breach of the “requirement of good faith” now imported into English law by Regulation 5(1) (ex 4(1)). As to the second, it may, in fact be both. The Director General, in discharge of his Regulation 10(1) (ex 8(1)) duties, has perforce, notwithstanding that a complainant may be an individual aggrieved consumer, to apply some general test. By contrast, that same individual in seeking to claim that a term is unfair and so, by virtue of Regulation 8(1) (ex 5(1)), not binding on him/her, must be entitled to ask to be considered as an individual. The consumer’s intelligence, literacy, understanding of “business” matters and so on will all be “circumstances attending the conclusion of the

contract” as specified in Regulation 6(1) (ex 4(2)). The whole tenor of the 1994 Second Schedule required concentration on the specific parties to the contract in question and it is submitted that its excision does not weaken this general point of subjectivity. If this is so, then, as the writer has said elsewhere, “It is ironic that the average man on the Clapham omnibus might well not know, today, what an omnibus is, let alone recognise the Latin pun involved”, so the standard may be set at a low level in respect of an unsophisticated consumer. That “basis of the contract”, however plain, is unintelligible to the overwhelming majority of consumers seems unarguable.

Unfair Contract Terms Bulletins Following the coming into force of the Regulations, the Office of Fair Trading created an Unfair Contract Terms Unit, which has issued a series of Bulletins on its work, the latest (at the time of writing) No 7 in July 1999 which follows an announcement in October 1998 that it was intended to collect the case studies to that date into a form of digest, to be updated with future developments, while the Bulletins would in future concentrate on the monitoring and enforcement work of the Unit. The case reports add further force to the writer’s contention that basis of contract clauses would not survive onslaught from the Regulations. For example, the presence of “this does not affect your statutory rights” incurred the displeasure of the O.F.T. because it is plain language that is not intelligible. The Bulletin explains that “without further explanation it is simply meaningless to consumers” (which is exactly the major complaint about the far-reaching consequences of the seemingly simple “basis of the contract” phrase). The explanation continues that the wording (despite, it must be said, its appearance in the relevant Regulations”) “cannot

prevent them [ie consumers] from being misled into believing that an ineffective exclusion clause denies them redress”. That provides the perfect retort to those who would excuse the continued use of the phrase, despite the A.B.I. ban on its use, by some such comment as “well, its inclusion does little harm because an A.B.I. member (or Lloyd’s Underwriter) would never rely on it and, if it did, the Ombudsman would swiftly overrule it”. Clearly the O.F.T. is against ineffective provisions which nevertheless have deterrent potential.

Other points Two more points appear from the Bulletins. Referring back to the entire contract provision employed by one A.B.I. member (but without a basis provision) it is significant that Bulletin 5, and earlier Bulletins, record a number of cases where the O.F.T. opposition has led to their discontinuance. Secondly, up to October 1998, the O.F.T. had not sought an injunction but had apparently threatened to do so on several occasions.

The NCC Proposals Recommendation 7 of the National Consumer Council in May 1997 Report on Insurance Law Reform reads simply “We recommend a legal prohibition on ‘basis of the contract’.” There has been no hint of Ministerial interest in pursuing any of the recommendations, and 40 years’ inaction on previous reform proposal is not a good omen. Nevertheless, the writer hopes that he has shown how that result could now be achieved, for consumer cases, with the legislative weapons already to hand. Whether the will exists to wield them remains to be seen.’

Note: Opportunities for judicial consideration of the Regulations are likely to be rare given that they apply only to ‘consumer-insureds’ and the Financial Services Ombudsman will therefore decide most disputes. However, the opportunity did arise for the first time in Bankers Insurance Co Ltd v South [2003] EWHC 380. Buckley J’s observations provide some insight for insurers on the scope of the Regulations particularly in relation to conditions governing claims. The judge’s reasoning is somewhat obscure, but, having reviewed the common law position, he explained that an insured may be deprived of cover simply because he or she has transgressed procedurally a claims condition even though no harm as such is suffered by the insurer. Buckley J was thus driven to hold that the fairness provisions of the Regulations applied. This finding placed the judge in a conundrum. Having construed the particular conditions as conditions precedent to recovery (as opposed to innominate terms) so that on the basis of the 1994 Regulations they were not binding on the insured, this would, on the facts before him, clearly cause grave injustice to the insurers who had suffered significant prejudice as a result of the insured’s serious delay in notifying them of a claim. The solution adopted by the judge was to hold that only that part of the condition denying recovery whatever the consequences of the breach was not binding on the insured (see Regulation 5(2), extracted in Buckley J’s judgment below). Thus, the

insured’s serious and prejudicial breach amounted to a repudiation that discharged the insurers from liability. [837] Bankers Insurance Co Ltd v South [2003] EWHC 380 [Bankers were the underwriters of South’s (S) holiday insurance policy that covered first party loss and third party liability. Section 9 of the policy excluded liability for accidents ‘involving [the insured’s] ownership or possession of any mechanically propelled vehicles…[or] motorised waterborne craft’. The policy also contained the following claims conditions: “(d) reporting in writing to us as soon as reasonably possible, full details of any incidents which may result in a claim under the policy; (e) forwarding to us immediately upon receipt, every writ, summons, legal process or other communication in connection with the claim.”

In July 1997 S was riding a jet ski and collided with another jet ski ridden by Gardner (G) causing G serious personal injuries. S failed to notify Bankers of the accident. In June 2000 G brought a claim against S but still S did not notify the underwriters until April 2001, having been pressed to do so by his solicitors. Bankers sought a declaration that it was not liable to indemnify S for any liability to G on the basis that: (1) the policy excluded ‘waterborne craft’; S argued that this term did not extend to a jet ski but if it did the

Unfair Terms in Consumer Contracts Regulations 1994 protected him. (2) that S was in breach of two conditions precedent ((d) and (e)) relating to claims; S argued that these conditions could not be enforced under the 1994 Regulations]. Buckley J: ‘The following issues arise:

Waterborne Craft Mr Lynagh [counsel for Bankers] submitted that a jet ski was plainly a waterborne craft within the meaning of section 9 of the policy and thus the accident did not fall within the cover provided or more precisely was expressly excluded. He referred to the Shorter Oxford English Dictionary and various regulations and manufacturers’ documents obtained from the internet… As to the material obtained from the internet, Mr Wyn Williams QC for Mr Gardner…responded to Mr Lynagh’s submission in two ways. First, he submitted a jet ski was not a craft. He referred to the Oxford English Dictionary and the general understanding of the word. Secondly, that if a jet ski was a craft the exclusion of it in section 9 was an unfair term within the meaning of the Unfair Terms in Consumer Contracts Regulations 1994 (“the 1994 Regulations”), the material parts of which are as follows: Terms to Which These Regulations Apply Regulation 3 provides: “(1) Subject to the provisions of Schedule 1 these Regulations apply to any term in a contract included between a seller or supplier and a consumer where the said term has not been individually negotiated. (2) Insofar as it is in plain, intelligible language, no assessment shall be made of the fairness of any term

which — (a) defines the main subject matter of the contract, or (b) concerns the adequacy of the price or remuneration, as against the goods or services sold or supplied. (3) For the purpose of these Regulations, a term shall always be regarded as not having been individually negotiated where it has been drafted in advance and the consumer has not been able to influence the substance of the term. Regulation 4 provides: (1) In these Regulations, subject to paragraphs (2) and (3) below, “unfair term” means any term which contrary to the requirement of good faith causes a significant imbalance in the parties rights and obligations under the contract to the detriment of the consumer. (2) An assessment of the unfair nature of the term shall be made taking into account the nature of the goods or services for which the contract was concluded and referring, as at the time of the conclusion of the contract, to all circumstances attending the conclusion of the contract and to all other terms of the contract or of another contract on which it is dependent.” For enlightenment on “good faith” and illustrations of “unfair terms” reference is made to Schedules 2 and 3. Schedule 2 Assessment of good faith: “In making an assessment of good faith, regard shall be had in particular to — (a) the strength of the bargaining positions of the parties; (b) … (c) … (d) the extent to which the seller or supplier has dealt fairly and equitably with the consumer.”

Schedule 3 Illustrations of unfair terms: “1. Terms which have the object or effect of: … (i) irrevocably binding the consumer to terms with which he had no real opportunity of becoming acquainted before the conclusion of the contract. Regulation 5 Consequence of inclusion of unfair terms in contracts: “(1) An unfair term in a contract concluded with a consumer by a seller or supplier shall not be binding on the consumer.” Regulation 6 Construction of written contracts: “A seller or supplier shall ensure that any written term of a contract is expressed in plain, intelligible language, and if there is doubt about the meaning of a written term, the interpretation most favourable to the consumer shall prevail.” It was agreed that the insurance policy in this case was subject to those Regulations. It was also agreed that section 9 of the policy contained terms which “defined the main subject matter of the contract”. Mr Williams, however, submitted it was not in “plain, intelligible language….” I did not obtain much assistance from the dictionary references albeit, the Shorter Oxford English Dictionary under the heading “personal watercraft” (chiefly US) refers to a jet ski. The Oxford English Dictionary does not mention a jet ski but refers to craft as applied to boats, ships and fishing requisites. It also refers to “vessels of all kinds for water carriage and transport” and “a small vessel or boat; any sailing or floating vessel.”

The manufacturers’ material refers to jet skis as “personal watercraft” and as “craft”. A safety document which appears to be produced by some Cornish tourist agency also refers to jet skis as craft as do Guidelines for the Safe Operation of Beach Hired Pleasure Craft issued by the Maritime and Coastguard Agency. These guidelines refer to personal water craft (PWC) and include jet skis and wet bikes. A document headed Department of the Environment, Transport and the Regions Transport Statistics Great Britain: 2000 Edition includes under the heading Pleasure Craft a reference to jet skis (personal watercraft). A document produced by the Scout Association headed Personal Watercraft also refers to personal watercraft often being called jet skis and uses the word “craft” in general terms suggesting that it includes jet skis. All those documents were obtained from the internet and I have indicated how I approach them. I was referred to the Recreational Craft Regulations 1996. They contain no express reference to jet skis but the word “craft” is used liberally and in a fairly general sense. Finally, the Porthmadog Harbour Revision Order 1998 in its definition section refers to personal watercraft as being “any watercraft…propelled by jet engine or other mechanical means of propulsion and steered either: (a) by means of a handlebar-operated linkage system.… (b) by the person or persons riding the craft using his or their body weight for the purpose; or (c) by combination of the methods referred in (a) and (b) above.” That would clearly include a jet ski. These references provide some support for Mr Lynagh’s broad submission that the word “craft” is in common usage in a very broad sense which would include a jet ski. In Steedman v Scofield [1992] 2 Lloyd’s Rep 163 Sheen J held that a jet ski was not a boat nor was it a vessel or ship within the meaning of the Merchant Shipping Acts but Mr Lynagh drew attention to various passages in which Sheen J used the word “craft” in a

broad sense which, he submitted, would comprehend a jet ski. Indeed, after quoting from advertising material which described a jet ski, Sheen J posed the question “Is this craft, as the Defendants contend, a boat?” In reaching his conclusion in that case he referred to a decision of Roskill J, as he then was, in Dependable Marine Co Ltd v Customs and Excise Commissioners [1965] 1 Lloyd’s Rep 550 in which Roskill J had to decide whether a skicraft was a boat or other vessel large enough to carry human beings. The quotation from Roskill J’s judgment includes numerous references to “this craft” or “a craft” used in a general sense, for example “accordingly this craft was not a boat or vessel….” Mr Williams submitted that Sheen J had been led into his general use of the word “craft” by the references to the manufacturers’ publicity material. There may be some force in that submission but considering the judgment as a whole and also the quotation from Roskill J, it seems to me that both those judges, who were very experienced in such matters, were indeed using the word “craft” in a very general sense and one wide enough to comprehend a jet ski. I must endeavour to give the word “craft” its ordinary natural meaning as at the time of this contract, that is 1997, and as it is used in section 9. In particular, its immediate context which, as quoted above, is: “mechanically propelled vehicles and any trailers attached thereto, aircraft, motorised waterborne craft or sailing vessels or windsurfing.” In my view that is plainly a description which comprehends a jet ski and one which would be so understood by any reasonable insured who troubled to read the policy wording. As to Mr Williams’ submission on the 1994 Regulations, I consider section 9 to be in “plain and intelligible language” thus pursuant to Regulation 3 (2) “no assessment shall be made of the fairness…” of the term. In any event I could see

nothing unfair in this term, within the meaning of these Regulations. If I had been called upon to consider “unfairness” and, pursuant to Regulation 4 (2), I had had regard to the nature of the insurance contract and the circumstances attending its conclusion, I would have considered that [the insured] could have read the policy wording which I have found was available and could have asked Miss Perry [the travel agent who arranged the holiday insurance] whether it covered jet skis if he was in any doubt or even if he couldn’t be bothered to read all the wording. This was a relatively cheap holiday or travel insurance and on the evidence I could detect nothing inappropriate let alone unfair in the circumstances attending its conclusion…

Possession Mr Williams submitted that although Mr South could be said to have been in possession of a jet ski he had hired and was riding, nevertheless, the words: “Compensation…arising from accidents involving your… possession of any: waterborne craft…” were ambiguous. He pointed out that accidents could arise from possession without use and that use and possession were different concepts and if “use” use was intended to be excluded the policy should clearly have said so. He referred to the appearance of the word use in the exclusion of land or buildings in the preceding wording as supporting his theme. I cannot accept those submissions, presented as they were with Mr Williams’ customary skill. I agree with Mr Lynagh that Mr South clearly had possession of the jet ski and the accident involved his possession of it. I do not think anyone reading the exclusion could reasonably doubt that it

comprehended an accident while using a jet ski. The addition of use with reference to land or buildings is because it extends the exclusion to use by or on behalf of the insured other than temporary holiday or journey accommodation. I therefore hold that the accident Mr South had while riding a jet ski was clearly excluded from the events covered by the policy and that the 1994 Regulations do not affect that conclusion. Those holdings are sufficient to determine this matter, but Counsel addressed various other issues arising from the section of the policy headed Conditions, which I should deal with in case I am wrong so far.

Conditions Precedent Mr Lynagh submitted that sub-paragraphs (d) and (e), set out above, were conditions precedent to liability and since Mr South had manifestly failed to comply with either, Bankers should not be liable in any event. Mr Williams submitted that the words do not drive one to the conclusion that compliance is a condition precedent to payment and that (d) and (e) should be regarded as innominate terms. Further, that since the effect of the breaches here was not significant, in that no real prejudice accrued to Bankers, it should remain liable to pay. Both Counsel agreed that the fairness provisions of the 1994 Regulations applied to (d) and (e) and I agree. Mr Williams also submitted that any condition precedent, but certainly (d) and (e) which sought to exclude insurers liability to meet a claim notwithstanding that no prejudice had been caused by a breach was unfair… In my judgment the introductory words under the heading Conditions are apt to constitute (d) and (e) conditions precedent to the liability of Bankers. That seems to me to be the plain and ordinary meaning of the words and to hold

otherwise would involve a strained and unhelpful approach to construction of a document in common usage. The subject matter of such clauses, namely, prompt notification of claims or matters which may result in claims, is obviously important to insurers. Thus appropriately worded clauses of this sort have been accepted by the courts as conditions precedent on many occasions. However, bearing in mind the drastic consequences of noncompliance an element of reasonableness has often been read into the permitted time stipulated for compliance. I was not referred to any case which has considered the question Mr Williams raises, as to whether such clauses are inherently unfair and thus not binding on the insured, as a result of the 1994 Regulations. Clearly these clauses are important to insurers. Noncompliance by the insured can hopelessly prejudice the insurers’ right of subrogation and chance of recovery from another party. Further, it is not asking a great deal of an insured to pass on information which he has or receives, to the insurer, at least within a reasonable time. On those considerations alone it would be difficult to say that such a clause causes “a significant imbalance in the parties rights and obligations under the contract to the detriment of the consumer.” However, a breach by the insured may not prejudice the insurer. Even very late notification, may not necessarily cause difficulties. Thus these clauses may deprive an insured of the benefit for which he bargained or provide the insurer with a bonus, simply because the insured has transgressed procedurally, but without prejudice to the insurer. Provided such envisaged circumstances are not fanciful but may reasonably be contemplated and I think they can, it seems to me that it is appropriate to have them in mind when judging the term in question. By those criteria I would hold such clauses, including (d) and (e), to be fairness provisions of the 1994 Regulations applied.

Thus we arrive at the interesting situation in which such a clause, construed as a condition precedent, is unfair pursuant to the 1994 Regulations and therefore not binding on the insured, notwithstanding it could be regarded as equally unfair for the insurer to be called upon to indemnify the insured, even if its position has been hopelessly prejudiced by the insured’s inactivity. Two solutions seem to me to be available. The first, which I regard as unsatisfactory, would be to treat such clauses as innominate terms, however worded. The second, would be to hold that it is only that part of the clause denying recovery whatever the consequences of the breach, which is not binding on the insured. I regard this as consistent with the spirit, at least, of Regulation 5 (2): “The contract shall continue to bind the parties if it is capable of continuing in existence without the unfair term.” The result would be the same whichever solution is adopted. I prefer the second because I do not favour false or strained constructions of clauses in contracts. To delete such a clause altogether would produce an unfair result for the insurer and would not be in accordance with the objective of the Regulations. Thus whether I am right or wrong in my construction of this clause, the question of the effect of Mr South’s breaches of (d) and (e) arises. If the accident had been notified promptly, the issue of cover would probably have been resolved, even by court proceedings, by late 1999. Thus investigations, if called for, could have begun over three years ago. Amongst the witness statements in the possession of the police are several from witnesses to the accident. This is just the sort of case in which memories will fade, albeit most dramatically in the months immediately following the accident. Some witnesses may now be hard or practically impossible to trace. Mr Williams, however, pointed out that

even now Bankers had taken no steps to investigate, which is consistent with Mr Byron’s evidence that it would not have done so at the time, at least not before the dispute over cover had been resolved. However, Mr Byron also said that the matter would have been referred to Cameron McKenna [solicitors for Bankers], assuming cover was contested, and Bankers would have followed their advice. I have no evidence from Cameron McKenna but I don’t suppose they could now say with any certainty how they would have reacted in 1997. It is certainly possible that they would have advised that some prompt inquiries be made and steps taken to secure a nucleus of witness statements in order to protect Bankers’ position should it be held on risk. I was referred to McAlpine v BAI (Run-off) [2000] Lloyd’s Rep 437 at 444 paragraph 34, where Waller LJ. said: “Condition 1.(a). is however a 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.” Mr Lynagh submitted that Mr South’s breaches of (d) and (e) had serious consequences for Bankers and/or manifested an intention not to make a claim.

The breaches of conditions (d) and (e) were manifestly serious from one point of view, namely, that Bankers received no notification of the accident in July 1997 nor any claim in respect of it before Hextall Erskine’s [solicitors for G] letter dated 23 November 2000 to Ketteridge. Mr South himself made no claim on Bankers until his letter dated 27 April 2001. Whilst it does not necessarily follow that such prolonged delay would have serious consequences for Bankers, the position here, as already mentioned, is that by the time the question of cover is resolved Bankers will have lost some three and a half years. On the evidence before me I draw the following inferences: i. Some significant further fading of memories will have occurred; ii. Some of the witnesses will probably be more difficult to trace and some will probably be unwilling to assist after so long. Once Bankers had become aware of Mr Gardner’s claim against Mr South as a result of Hextall Erskine’s involvement for Mr Gardner, they referred the matter to Cameron McKenna who wrote two very fair letters to Mr South. Neither received any response, despite the reference in the second letter to Mr South not considering himself insured. That remark was as a result of information from Hextall Erskine. The lack of response to those two letters coming on top of the passage of almost three and a half years since the accident, in my judgment, demonstrates an intention on behalf of Mr South not to claim. Having seen the correspondence passing between the interested parties, I am satisfied that Mr South would not have made a claim on Bankers save for the perfectly proper and understandable encouragement to do so from Hextall Erskine. Whether they are acting directly for Mr Gardner or for any insurers he may have I know not, but it was clearly in their interests to persuade Mr South to notify Bankers and they manifestly succeeded in doing so. I intend no criticism at all of Hextall

Erskine who acted entirely properly throughout. The fact that Mr South was persuaded to notify Bankers in those circumstances does not change the conclusion I have reached, nor does the fact that at some stage Bankers may have realised that Hextall Erskine would encourage Mr South to make a claim. The effective delay of over three years with the consequences I have described, is in my view serious for Bankers. I do not see why Bankers should, at the present time, be expected to run up further significant costs probably involving some legal procedures in order to obtain statements from the Cypriot police or endeavour to trace witnesses, until the question of cover is resolved. Thus I conclude that Bankers falls within both limbs of paragraph 34 of Waller LJ’s judgment…’

9 Construction of Contract Terms 9.1 General Principles of Construction It remains a fundamental tenet of contract law — and, therefore, of insurance contract law — that the parties are free to make their agreement. This means that most of the rules of insurance law may be excluded, waived or varied by the parties. It is, therefore, to the insurance contract that the lawyer must turn in order to determine the rights and obligations of the parties, and an insurance contract is construed according to the same principles that apply to all contracts. The situation is somewhat different in many other countries where terms and premium rates are controlled (for example in the USA, see KS Abraham, Insurance Law and Regulation (New York, Foundation Press, 2000 and Part 9.3). The starting point for English judges when approaching the construction of a contract was succinctly stated by Mance LJ in Sinochem International Oil (London) Co Ltd v Mobil Sales and Supply Corpn [2000] 1 Lloyd’s Rep 339 (CA): ‘The Court cannot either re-write contracts or impose on

parties to them what the Court may think would have been a reasonable contract.’ [901] Prenn v Simmonds [1971] 3 All ER 237 (HL) Lord Wilberforce: ‘There were prolonged negotiations between solicitors, with exchanges of draft clauses, ultimately emerging in clause 2 of the agreement. The reason for not admitting evidence of these exchanges is not a technical one or even mainly one of convenience…It is simply that such evidence is unhelpful. By the nature of things, where negotiations are difficult, the parties’ positions, with each passing letter, are changing and until the final agreement, though converging, still divergent. It is only the final document which records a consensus. If the previous documents use different expressions, how does construction of those expressions, itself a doubtful process, help on the construction of the contractual words? If the same expressions are used, nothing is gained by looking back; indeed, something may be lost since the relevant surrounding circumstances may be different…In my opinion, then, evidence of negotiations, or of the parties’ intentions, and a fortiori of Dr Simmonds’s intentions, ought not to be received, and evidence should be restricted to evidence of the factual background known to the parties at or before the date of the contract, including evidence of the “genesis” and objectively the “aim” of the transaction.’

[902] Reardon Smith Line Ltd v Hansen-Tangen [1976] 3 All ER 570 (HL) Lord Wilberforce:

‘It is less easy to define what evidence may be used in order to enable a term to be construed. To argue that practices adopted in the shipbuilding industry in Japan, for example as to subcontracting, are relevant in the interpretation of a charterparty contract between two foreign shipping companies, whether or not these practices are known to the parties, is in my opinion to exceed what is permissible. But it does not follow that, renouncing this evidence, one must be confined within the four corners of the document. No contracts are made in a vacuum: there is always a setting in which they have to be placed. The nature of what is legitimate to have regard to is usually described as “the surrounding circumstances” but this phrase is imprecise: it can be illustrated but hardly defined. In a commercial contract it is certainly right that the court should know the commercial purpose of the contract and this in turn presupposes knowledge of the genesis of the transaction, the background, the context, the market in which the parties are operating. I give a few illustrations. In The Utica City National Bank v Gunn the New York State Court of Appeals had to consider the meaning of “loans and discounts” in a contract of guaranty. The judgment of Cardozo J (222 NY 204 at 208) contains this passage: “The proper legal meaning, however, is not always the meaning of the parties. Surrounding circumstances may stamp upon a contract a popular or looser meaning. The words ‘loans and discounts’ are not so clear and certain that circumstances may not broaden them to include renewals. They often have that meaning in the language of business life…To take the primary or strict meaning is to make the whole transaction futile. To take the secondary or loose meaning, is to give it efficacy and purpose. In such a situation, the genesis and aim of the transaction may rightly guide our choice…”

…It is often said that, in order to be admissible in aid of construction, these extrinsic facts must be within the knowledge of both parties to the contract, but this requirement should not be stated in too narrow a sense. When one speaks of the intention of the parties to the contract, one is speaking objectively — the parties cannot themselves give direct evidence of what their intention was — and what must be ascertained is what is to be taken as the intention which reasonable people would have had if placed in the situation of the parties. Similarly, when one is speaking of aim, or object, or commercial purpose, one is speaking objectively of what reasonable persons would have in mind in the situation of the parties. It is in this sense and not in the sense of constructive notice or of estopping fact that judges are found using words like “knew or must be taken to have known” (see, for example, the well-known judgment of Brett LJ in Lewis v Great Western Railway Co ((1877) 3 QBD 195 at 207). …[W]hat the court must do must be to place itself in thought in the same factual matrix as that in which the parties were. All of these opinions seem to me implicitly to recognise that, in the search for the relevant background, there may be facts, which form part of the circumstances in which the parties contract, in which one or both may take no particular interest, their minds being addressed to or concentrated on other facts, so that if asked they would assert that they did not have these facts in the forefront of their mind, but that will not prevent those facts from forming part of an objective setting in which the contract is to be construed.’

[903] Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 All ER 98 (HL)

Lord Hoffmann: ‘…I think I should preface my explanation of my reasons with some general remarks about the principles by which contractual documents are nowadays construed. I do not think that the fundamental change which has overtaken this branch of the law, particularly as a result of the speeches of Lord Wilberforce in Prenn v Simmonds [1971] 3 All ER 237 at 240–42, [1971] 1 WLR 1381 at 1384–1386 and Reardon Smith Line Ltd v Hansen-Tangen, Hansen-Tangen v Sanko Steamship Co [1976] 3 All ER 570, [1976] 1 WLR 989, is always sufficiently appreciated. The result has been, subject to one important exception, to assimilate the way in which such documents are interpreted by judges to the common sense principles by which any serious utterance would be interpreted in ordinary life. Almost all the old intellectual baggage of “legal” interpretation has been discarded. The principles may be summarised as follows. (1) Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract. (2) The background was famously referred to by Lord Wilberforce as the “matrix of fact”, but this phrase is, if anything, an understated description of what the background may include. Subject to the requirement that it should have been reasonably available to the parties and to the exception to be mentioned next, it includes absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man. (3) The law excludes from the admissible background the previous negotiations of the parties and their

declarations of subjective intent. They are admissible only in an action for rectification. The law makes this distinction for reasons of practical policy and, in this respect only, legal interpretation differs from the way we would interpret utterances in ordinary life. The boundaries of this exception are in some respects unclear. But this is not the occasion on which to explore them. (4) The meaning which a document (or any other utterance) would convey to a reasonable man is not the same thing as the meaning of its words. The meaning of words is a matter of dictionaries and grammars; the meaning of the document is what the parties using those words against the relevant background would reasonably have been understood to mean. The background may not merely enable the reasonable man to choose between the possible meanings of words which are ambiguous but even (as occasionally happens in ordinary life) to conclude that the parties must, for whatever reason, have used the wrong words or syntax (see Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1976] 3 All ER 352, [1997] 2 WLR 945. (5) The “rule” that words should be given their “natural and ordinary meaning” reflects the commonsense proposition that we do not easily accept that people have made linguistic mistakes, particularly in formal documents. On the other hand, if one would nevertheless conclude from the background that something must have gone wrong with the language, the law does not require judges to attribute to the parties an intention which they plainly could not have had. Lord Diplock made this point more vigorously when he said in Antaios Cia Naviera SA v Salen Rederierna AB, The Antaios [1984] 3 All ER 229 at 233, [1985] AC 191 at 201:

“…if detailed semantic and syntactical analysis of words in a commercial contract is going to lead to a conclusion that flouts business common sense, it must be made to yield to business common sense.” …Finally, on this part of the case, I must make some comments upon the judgment of the Court of Appeal. Leggatt LJ said that his construction was “the natural and ordinary meaning of the words used”. I do not think that the concept of natural and ordinary meaning is very helpful when, on any view, the words have not been used in a natural and ordinary way. In a case like this, the court is inevitably engaged in choosing between competing unnatural meanings. Secondly, Leggatt LJ said that the judge’s construction was not an “available meaning” of the words. If this means that judges cannot, short of rectification, decide that the parties must have made mistakes of meaning or syntax, I respectfully think he was wrong. The proposition is not, I would suggest, borne out by his citation from Alice Through the Looking Glass. Alice and Humpty Dumpty were agreed that the word “glory” did not mean “a nice knock-down argument”. Anyone with a dictionary could see that. Humpty Dumpty’s point was that “a nice knock-down argument” was what he meant by using the word “glory”. He very fairly acknowledged that Alice, as a reasonable young woman, could not have realised this until he told her, but once he had told her, or if, without being expressly told, she could have inferred it from the background, she would have had no difficulty in understanding what he meant.’

[904] Jumbo King Ltd v Faithful Properties Ltd FACV000007/1999 (Court of Final Appeal (Civil), Hong Kong)

Lord Hoffmann: ‘In the present case, I do not think that there can be any doubt about what the parties intended. In my respectful opinion, the judge’s approach was far too narrow and literal. The construction of a document is not a game with words. It is an attempt to discover what a reasonable person would have understood the parties to mean. And this involves having regard, not merely to the individual words they have used, but to the agreement as a whole, the factual and legal background against which it was concluded and the practical objects which it was intended to achieve. Quite often this exercise will lead to the conclusion that although there is no reasonable doubt about what the parties meant, they have not expressed themselves very well. Their language may sometimes be careless and they may have said things which, if taken literally, mean something different from what they obviously intended. In ordinary life people often express themselves infelicitously without leaving any doubt about what they meant. Of course in serious utterances such as legal documents, in which people may be supposed to have chosen their words with care, one does not readily accept that they have used the wrong words. If the ordinary meaning of the words makes sense in relation to the rest of the document and the factual background, then the court will give effect to that language, even though the consequences may appear hard for one side or the other. The court is not privy to the negotiation of the agreement — evidence of such negotiations is inadmissible — and has no way of knowing whether a clause which appears to have an onerous effect was a quid pro quo for some other concession. Or one of the parties may simply have made a bad bargain. The only escape from the language is an action for rectification, in which the previous negotiations can be examined. But the overriding objective in construction is to give effect to what a reasonable person rather than a pedantic lawyer would have understood the

parties to mean. Therefore, if in spite of linguistic problems the meaning is clear, it is that meaning which must prevail.’

[905] MSC Mediterranean Shipping Co SA v Polish Ocean Lines (The Tychy) (No 2) [2001] 2 Lloyd’s Rep 403 (CA) Lord Phillips MR: ‘With respect to Lord Hoffmann, we are inclined to think that a little intellectual hand luggage is no bad thing when approaching the task of construing a contract. Before taking extrinsic evidence into account, it is important to consider precisely why it is said to assist in deciding the meaning of what was subsequently agreed and to consider whether its relevance is sufficiently cogent to the determination of the joint intention of the parties to have regard to it. It is also important, though not always easy, to identify what is extrinsic to the agreement and what forms an intrinsic part of it. When a formal contract is drawn up and signed, care must be taken to distinguish between admissible background evidence relating to the nature and object of the contractual venture and inadmissible evidence of the terms for which each party was contending in the course of negotiations. Where, as in the present case, an agreement is alleged to have been reached in the course of dealings which do not culminate in the drawing up of a formal contract, the task is to identify whether, and if so which, terms proposed in the course of negotiations have become the subject of a joint agreement.’

Notes: 1. In Bank of Credit and Commerce International SA (In Liquidation) v Ali [2001] 2 WLR 735 (HL) Lord Hoffmann qualified his earlier view by

stating that the factual background to which reference could be made was only such as the reasonable person would regard as being relevant. 2. There are several problems with Lord Hoffmann’s purposive approach. One is that it raises the prospect of uncertainty as to the meaning of a term because it may be difficult to foresee how a court would define the commercial purpose of any particular agreement and, of course, uncertainty increases litigation and costs. Indeed, the difficulty of fixing a precise meaning was brought home to Lord Hoffmann himself when he was the sole dissenting voice in Bank of Credit and Commerce International SA (In Liquidation) v Ali [2001] 2 WLR 735 (HL) on the issue of how his own principles were to be applied. Another problem lies in the apparent encouragement that Lord Hoffmann’s fourth and fifth principles give to those who wish to remake a contract. The courts have always taken the view that they will apply the clear meaning of words even if that meaning appears unreasonable. On the other hand, as Lord Reid pointed out, ‘The fact that a particular construction leads to a very unreasonable result may be a relevant consideration. The more unreasonable the result the more unlikely it is that the parties can have intended it, and if they do intend it the more necessary it is that they shall make that intention abundantly clear.’ (L Schuler AG v

Wickman Machine Tool Sales Ltd [1974] AC 235 at 251) Speaking before the West Bromwich case of the requirement that the courts look at the surrounding circumstances of the contract, Staughton LJ remarked, ‘Almost every day in these courts there is a contest as to what comes within that description.’ (Youell and Others v Bland Welch & Co Ltd and Others at [908] below) Yet he did not regard this as a cause for alarm. And in truth, the meaning of contracts is not always clear. This is often simply because contracts govern future dealings between contracting parties, who are understandably more focused on performance than breach and who are, perhaps, not gifted with well-honed powers of prophecy. The unforeseen problems that arise as a result and that lead to litigation must, nevertheless, be dealt with by the courts according to what the judge can determine was — on an objective test — the intention of the parties at the time of the contract. 3. The parol evidence rule is to the effect that ‘parol testimony cannot be received to contradict, vary, add to or subtract from the terms of a written contract’ (Bank of Australia v Palmer [1897] AC 540, per Lord Morris). The Law Commission has commented that the rule turns out to be, ‘no more than a circular statement’ since the cases show that, ‘Evidence will only be excluded when its

reception would be inconsistent with the intention of the parties’ (Law Commission, Law of Contract: The Parol Evidence Rule, Law Comm No 154, 1986, paras 2.7 and 2.45). So, for instance, evidence can be admitted to support rectification on the ground that the document does not accurately represent the agreement, or to show the circumstances at the time of the contract, where the policy is unintelligible without them, or to reveal the existence of a collateral contract (see Youell and Others v Bland Welch & Co Ltd and Others at [908] below). In Shepherd v National Mutual Life Association of Australasia Ltd (1995) 5 ANZ Ins Cas 61-233 (Supreme Court of Victoria), the insurers’ agent orally agreed to provide cover from the moment of acceptance, but the written policy which was later provided stated that cover commenced only after three months from the date of acceptance; the agent told the insured that this provision did not apply to him. It was held that the policy should be read subject to the oral promise about immediate cover.

9.2 Construing Insurance Contracts The general principles of construction are, of course, applied to insurance contracts. This means that cases decided before the line of modern cases beginning

with Prenn v Simmonds need to be approached with sensible caution. [906] Jason v Batten (1930) Ltd [1969] 1 Lloyd’s Rep 281 Fisher J: ‘I have to construe the policy and apply it to the facts which I have found. A policy of insurance is subject to the same rules of construction as any other written contract. The words used in it must be given their plain, ordinary meaning in the context of the policy looked at as a whole, subject to any special definitions contained in the policy. In case of ambiguity the contra proferentum rule will apply but apart from this there is no rule of law which requires me to strain the language of the policy in favour of or against the insured person. It is a bargain by which, in consideration of a relatively small premium, the insurance company agrees to make substantial payments in certain events, and it would be no less of an injustice to compel payment in events not falling within the ordinary meaning of the words used in the policy than to deny payment in events falling within such meaning.’

[907] Harris v Poland [1941] 1 KB 462 [The contents of Mrs Harris’s flat were covered for, among other things, loss by fire. Mrs Harris, fearing burglary, hid some jewellery under wood and coal in the grate. Later that day, forgetting the presence of the jewellery, she lit a fire. It was held that the insurers were liable for the loss.] Atkinson J:

‘There are one or two well settled rules of construction with regard to policies. One is that the construction depends not upon the presumed intention of the parties but upon the meaning of the words used. In Nelson Line (Liverpool) v James Nelson & Sons (No. 2) [1908] AC 16, 20 Lord Loreburn LC said: “I know of only one standard of construction, except where words have acquired a special conventional meaning, namely, what do the words mean on a fair reading, having regard to the whole document?” There is another rule which I find summarised in Hamlyn & Co v Wood & Co. [1891] 2 QB 488, 491 from Lord Esher’s judgment: “I have for a long time understood that rule to be that the Court has no right to imply in a written contract any such stipulation, unless, on considering the terms of the contract in a reasonable and business manner, an implication necessarily arises that the parties must have intended that the suggested stipulation should exist. It is not enough to say that it would be a reasonable thing to make such an implication. It must be a necessary implication in the sense that I have mentioned.” Another rule of construction is that as a policy is prepared by the underwriters any ambiguity therein must be taken most strongly against the underwriters by whom it has been prepared. If a policy is reasonably susceptible of two constructions, that one will be adopted which is more favourable to the insured. Again, in West India and Panama Telegraph Company v Home and Colonial Marine Insurance Company (1880) 6 QB D 51, 58, Brett LJ said this: “An English policy is to be construed according to the same rules of construction, which are applied by English Courts to the construction of every other mercantile instrument. Each term in the policy, and each phrase in the policy, is prima facie to be construed according to its ordinary meaning.” Guided by these principles I can see no reason whatever for limiting the indemnity given by the policy in the way claimed by the defendant. In my judgment the risks against

which the plaintiff is insured include the risk of insured property coming unintentionally in contact with fire and being thereby destroyed or damaged, and it matters not whether that fire comes to the insured property or the insured property comes to the fire. The words of the policy are just as descriptive of one as the other, and I cannot read into the contract a limitation which is not there. To enable me to accept the contention of the underwriters I should have to read something into the contract — some such words as “unless the insured property is burned by coming in contact with fire in a place where fire is intended to be.” What justification can there be for so doing? To what absurdities would it lead? A red hot cinder jumps from the fire and sets some paper of value on fire — admittedly there is liability. A draught from the window blows the same paper into the same fire. Is that any less an accidental loss by fire? Are the words in the policy any less applicable to the latter than the former? A draught blows the flame of a candle against a curtain — admittedly there is liability. But what if the curtain is blown against the flame of the candle? Surely the result must be the same? If it is not the same the result is an absurdity. If it is the same, why should the result be different if one substitutes a fire in a grate for the lighted candle in a candle stick?’

[908] Youell and Others v Bland Welch & Co Ltd and Others [1992] 2 Lloyd’s Rep 127 (CA) [This case concerned reinsurance, which enables insurers to spread the risks they underwrite. A reinsurance contract is entered into by an insurer (who becomes the reinsured) and a reinsurer. The reinsurer agrees to indemnify the reinsured against all or part of any loss under a policy or group of

policies. For a brief overview of the subject see, J Lowry and PJ Rawlings, Insurance Law: Doctrines and Principles (Oxford, Hart Publishing, 1999), chapter 14. For a fuller exposition, see JS Butler & R Merkin, Reinsurance Law (Kingston-upon-Thames, Kluwer Publishing, 1999). Y insured some liquefied natural gas carriers, which were being built in the USA. The cover provided for a primary period of insurance with an option to the insured to extend. Y reinsured with B ‘risks attaching for periods as original (up to but not exceeding 48 months)’. The carriers became total losses at a time when still under the cover provided by Y, but more than 48 months after they had come on risk. Y’s claim against B was rejected at first instance and in this appeal]. Staughton LJ: ‘…The problem A contract of insurance almost invariably defines the period of time within which some relevant event must occur if the insurer is to be liable; or at any rate I have never met one which did not do so… How is the relevant period of cover to be defined? Generally the requirement is that the loss must occur within a period of, say, one year from the making of the contract. But there are exceptions. A common example arises in the field of professional indemnity insurance. There policies frequently cover not liability for negligent acts or omissions during the policy period, but liability for claims first made during the policy period. When it comes to reinsurance there are at least two methods that are commonly used. The first is the loss occurring method: the reinsurers are obliged to pay their share of the loss suffered by the reinsured, if it occurred

during the period when the reinsurance contract was in force, even if the original insurance commenced before the beginning of that period. The second is the risks attaching method: the reinsurers are then liable for their share of loss suffered by the reinsured, whenever it occurs, provided that risk attached under the original insurance during the period of the reinsurance contract. The date when the original insurance contract is concluded is not necessarily the same as the date when risk attaches under it. But that is a refinement which need not concern us in the present case… In the present case one can start with the clause headed “Period of Reinsurance and Termination”. This makes it clear that the period began on a 1 January 1974, and was to continue for a year or any whole number of years until determined by 60 days’ notice. Thus far, the reinsurance might have been either on a loss occurring or a risks attaching basis; all that had been defined was the period of reinsurance. But it is then provided that termination is — …not to apply to risks for which the Reinsured is already committed or which are already ceded hereunder. That is, to my mind, an indication that the reinsurance is on a risks attaching basis, or possibly on the basis of insurance contracts underwritten during the reinsurance period. The point is dealt with further and explicitly by the words “in respect of risks attaching” in the clause headed “Interest and Subject Matter”. It is now clear that the reinsurers are to be liable if during the period of the reinsurance contract risk attaches under an original insurance, and if the insurers become liable for a loss under that original insurance at any time during the period which it provides for, although the loss occurs after the expiry of the reinsurance period. (It is possible that there would be reinsurance cover even if the risk had not attached during the reinsurance period, owing to the words, “for which the reinsured is already committed”

in the period of reinsurance clause. But that point does not arise in this case.) The difficulty arises from 11 words in the interest and subject matter clause: “…for periods as original (up to but not exceeding 48 months).” Do these words, as the insurers contend, describe the type of insurance contracts which are to be reinsured? If the original insurance is, as in the present case, for a basic period of 32 months although liable to be extended, is the requirement of those words satisfied? The alternative view, put forward by the reinsurers, is that the contract there contains a cut-off or long-stop, so that they are free from liability for any loss occurring more than 48 months after the original insurance attached, even if its basic period was, for example, 32 months. The reinsurance contract would then be a hybrid, partly on a risks attaching basis and partly on a loss occurring basis…

Practical considerations One can, I think, readily assume that a reinsurance contract was intended to cover the same risks on the same conditions as the original contract of insurance, in the absence of some indication to the contrary. Of course there may be reinsurance of specific perils which form part only of those covered by the original insurance, such as hurricane or fire; and there may be reinsurance against some types of loss, such as total loss only. But some express provision is required to achieve either of those results. On the other hand it is normal (although not universal) for a reinsurance contract to cover less than 100 per cent of the insurers’ liability, whether by way of share or of excess. In the particular context of this case, I would expect an insurer normally to require back-to-back reinsurance in respect of

the period of his liability. If the reinsurance is for a lesser period than that for which he has provided cover, it may be difficult for him later to obtain further reinsurance cover either by way of extension or from other insurers, especially if he has then to disclose circumstances which show that a loss may be imminent. So it can in my view be said that the reinsurance contract would have been a more sensible one from the insurers’ point of view, if it had the meaning which they contend for. In the event of a declaration being made under their open cover with a basic period exceeding 48 months, they would know at once that it did not come within their existing reinsurance, and would have to seek new terms for that particular vessel. Against that consideration, the reinsurers say that it might not in practice always be possible to tell whether a particular declaration was for a basic period of more or less than 48 months. Both the London Institute clauses for builder’s risks and the American clauses contemplate that a provisional or basic period will be agreed; but in practice this might not happen. There were periods of 32 months declared for the hull and machinery insurances in this case, but none were declared for the ancillary insurance on escalation and charges. It might, I suppose, reasonably be assumed that whatever period was declared for hull and machinery applied also to the ancillary insurances. I do not consider that significant weight should be given to the fact that this sort of difficulty might arise on the insurers’ interpretation of the reinsurance contract. It is not unknown for parties in this market to create difficulties by failing to operate the procedure which they have agreed on. In such a case the Courts have to do the best they can, in giving effect to the contract so far as possible despite the changed circumstances.

The premium

At first this seemed to me a major point in favour of the insurers. The premium under the original insurance was, as I have said, a fixed percentage of the vessel’s value and another (smaller) percentage for every month of the building period; and the percentage in each case was to be of the contract value of the vessel or the completed value, whichever was the greater. The reinsurers were to receive 25 per cent of the original premium. Yet on their interpretation of the contract they would come off risk when the value of the vessel could be expected to be highest; and however long construction continued after 48 months had expired, they would still receive 25 per cent of the fixed element of the premium under the original insurance. Against that there was evidence that the parties to the original insurance did in fact calculate the premium as a weighted average of the values at risk from time to time. I am not so much impressed by the fact that they did it, as by the fact that it was possible to make such a calculation and not thought to be an unreasonable interpretation of the original insurance contract. If such a calculation was appropriate as between the original insured and the insurers, a similar calculation could be done so as to allow for the expiry of the reinsurers’ risk after 48 months, and might be thought to be what the reinsurance contract required. The highest that this point can be put is that, if a cut-off of the reinsurers’ liability after 48 months was intended, it is surprising that there was no express provision as to the premium that would be payable in that event. But it is scarcely a novelty to find a lack of precise detail in a reinsurance contract, or that the parties have left some problem to be resolved by goodwill, good sense or (if necessary) some other means of dispute resolution if it arose.

The slip

Mr Mance for the reinsurers argued that it was permissible to refer to the slip as an aid to the interpretation of the reinsurance contract, and Mr Sumption for the insurers that it was not. It is now, in my view, somewhat old-fashioned to approach such a problem armed with the parol evidence rule, that evidence is not admissible to vary or contradict the words of a written contract. The modern approach of the House of Lords is that, on the positive side, evidence should be admitted of the background to the contract, the surrounding circumstances, the matrix, the genesis and aim. Almost every day in these Courts there is a contest as to what comes within that description. As Lord Wilberforce said in Reardon Smith Line Ltd v Hansen-Tangen the expression “surrounding circumstances” is imprecise. But so to some extent is “matrix”, if I may say so, although it is a picturesque metaphor. It may well be that no greater precision is possible. The notion is what the parties had in mind, and the Court is entitled to know, what was going on around them at the time when they were making the contract. This applies to circumstances which were known to both parties, and to what each might reasonably have expected the other to know. The negative aspect of the modern doctrine is that evidence of negotiations is not admissible as an aid to interpretation, at all events unless they show an agreed meaning for the language used…. It can be argued that an insurance slip is different from negotiations for the formation of a contract. It contains a concluded agreement between the parties, albeit one which they may expect, and even agree, to replace by different wording in a formal contract. The nature of the problem which then arises is clearly illustrated by the present case. The relevant reinsurance slip for present purposes is that which was initialled, wholly or for the most part, in November, 1973. Against the heading “Period” it provided:

“Continuous open cover commencing 1st January 1974 and/or as original subject to 60 days cancellation clause to any anniversary date (not to apply to risks for which reinsureds are already committed or which are already ceded hereunder). Risks attaching basis for periods as original but not exceeding 48 months any one risk.” There is provision for a particular form to be used, followed by the words — “…Wording to be agreed by leading London reinsurer.” There is another heading, “Interest”, which contains much of the wording that subsequently appeared in the policy under “Interest and Subject Matter”, but not any mention of the 48-month limit.” It is thus readily apparent that somebody, for some reason, has transferred the term as to 48 months from Period to Interest. But that is no help at all. Even if one could confidently discern what the words meant in the slip — which I do not think one can — there would remain the possibility, and perhaps even a probability, that the parties wished to alter that meaning when they prepared and agreed the policy. It is not argued that the leading underwriter had no authority to do so on behalf of others. I accordingly would hold that the slip, whether admissible or not, is of no assistance in this case. There was some discussion as to whether the reinsurance contract was ambiguous. I certainly agree that there is room for argument as to which of two meanings is correct; but the ambiguity is patent, or there for all to see. There is no special need for extraneous evidence either to create it or to resolve it. The Court has to determine which of the two meanings is to be adopted.

Contra proferentem

There are two well established rules of construction, although one is perhaps more often relied on with success than the other. The first is that, in case of doubt, wording in a contract is to be construed against a party who seeks to rely on it in order to diminish or exclude his basic obligation, or any common law duty which arises apart from contract. The second is that, again in case of doubt, wording is to be construed against the party who proposed it for inclusion in the contract: it was up to him to make it clear. I am not wholly sure which of these rules is meant by the Latin maxim verba chartarum fortius accipiuntur contra proferentem. Does it refer to the proferens coram judice (the first rule), or the proferens in contrahendo (the second)? No doubt diligent historical research would produce an answer. But it does not matter. All that we need do is remember the two rules. In the vast majority of cases the two rules will lead to the same result, for people do not usually propose wording which favours the other party rather than themselves. But here it is possible that the two rules point in different directions. There can be no doubt that the words “up to but not exceeding 48 months” are, in one way or the other, a limit on the primary obligation of the reinsurers. They are either not obliged to accept such risks at all, or their liability ceases when the 48-month period expires. So in case of doubt they fall to be construed against the reinsurers. But it is said that the words were proposed for inclusion in the contract by the insurers, and should be construed against them. It is here that difficulty arises from the fact that the case was tried in two separate parts. During the trial of the second part, between the insurers and the brokers, there was some evidence as to how the disputed words came to be included in the slip. But the reinsurers were at that stage no longer participating in the trial; they had gone on their way rejoicing, with a decision in their favour on the first

part. They no longer had an opportunity to call evidence, or to cross-examine, on this issue. If they had wished to call such evidence, they should have done so in the first stage of the trial. In those circumstances it seems to me that we must ignore the evidence as to who put forward the disputed wording, when deciding the first appeal. One is left only with the fact that it appeared in the slip, which is normally prepared by or on behalf of the party seeking insurance — or in this case, reinsurance. But if so it is a little odd, as I have indicated, that the wording appeared to contain a limit in favour of the reinsurers. On the whole I conclude that the proferens arguments do not in this case give rise to a presumption in favour of, or against, either party.

The answer Having considered the various extraneous aids to construction that were relied on, I find that they are of little help, and certainly do not indicate any firm preference for one meaning or the other. So I am left with the language of the contract. What the insurers are required to cede, and the reinsurers to accept, is as it seems to me a proportion of liability “for periods as original (up to but not exceeding 48 months)”. That, in my view, defines the time during which a proportion of the risk passes to the reinsurers. The words “in respect of risks attaching” are a separate provision, showing that the risks must attach under the original insurance during the year or years when the reinsurance contract remains in force. Those words serve a well known purpose on their own. Here they are as it were a parenthesis, and do not govern “for periods as original” etc. The language is not elegant, and on any view must be somewhat strained to make any sense. But the alternative view requires the whole phrase —

“…in respect of risks attaching for periods as original (up to but not exceeding 48 months)…” to be treated as one, describing the kind of liability which the insurers are to cede and the reinsurers to accept. This could be thought more appropriate to a clause headed “Interest and Subject Matter”, but it is to my mind a very strained construction. and “periods as original” must be taken to refer to the basic or provisional periods set out in the London or American clauses, not the periods for which the original insurances are, by their terms, liable to remain in force. That too I find implausible. In consequence I accept the reinsurers’ construction, and would dismiss the insurers’ appeal.’

Beldam LJ: ‘…as it was urged that the learned Judge [Phillips J, at first instance] had correctly held that consideration of the slip would infringe the parol evidence rule, I would make these comments. Firstly the rule (if rule it be) was analysed by the Law Commission in their Report on the Law of Contract — the Parol Evidence Rule (Law Com No 154). In para 1.2 the Commission identified three distinct rules generally rendering inadmissible evidence outside or extrinsic to a document in which the parties have recorded their transaction. The third of these rules was concerned with the interpretation of documents and with the extent to which parol evidence may be adduced to show what the parties to the document intended by the words used. This, as the Commission pointed out, was different from adducing such evidence for the purpose of contradicting, varying, adding to or subtracting from the terms of a written contract where its meaning was plain. The admission of extrinsic evidence as an aid to interpretation where the words of the written contract cannot be given a clear and unequivocal meaning

has been the subject of case law defining the extent to which such evidence may be adduced. For example, such evidence has been admitted to show that a particular expression was used in a special sense, and where one of the parties to the contract contends that the written document mistakenly records what had been agreed or mistakenly omits something which it was their common intention should be within the contractual document and claims rectification. When the written agreement has been rectified, it is not a written agreement with a parol variation. It is in fact the original agreement. Although the slip initialled by underwriters records the original agreement between the parties, if it contains words showing an intention that the terms will subsequently be incorporated into a policy form, when the policy has been issued it is the policy and not the slip which constitutes the contract or agreement between the parties. Reinsurers who invited the learned Judge to have regard to the wording of the slip as an aid to the interpretation of the contract did not seek rectification. The slip is clearly admissible in evidence for some purposes. Section 89 of the Marine Insurance Act, 1906 provides that reference may be made “as heretofor” to the slip or covering note in any legal proceeding. Prior to 1906 the extent of the slip’s admissibility after a policy had been signed was considered in Ionides v The Pacific Fire & Marine Insurance Co (1871) LR 6 QB 674. Lord Blackburn at p 685 indicated that, although the slip was clearly a contract of marine insurance, it was not a policy and not enforceable at law but it could be given in evidence wherever it was, though not valid, material. He held it was material in that case because the jury had decided that the contract evidenced by the slip was one by which insurers had bound themselves to insure hides shipped by the insured on ships declared by them, whatever the name or type of vessel. The insurers had sought to avoid the contract

by relying on a separate policy issued when the insured declared a parcel of hides on a ship whose name the underwriters’ clerk misspelt so that it indicated a ship more acceptable to insurers than the ship on which the hides were actually shipped. The later policy had been mistakenly issued by the underwriters’ clerk on the declaration when it was not intended by the parties that each declaration should be the subject of a separate policy. Lord Blackburn said the slip was material in that case because insurers were attempting to argue that on a declaration the name of the ship was a material matter and the slip could be given in evidence for the purpose of showing that it was not. This view was affirmed in the Exchequer Chamber (1873) LR 7 QB 517. Kelly CB stated that the slip was admissible, for example to show that the policy had been procured by misrepresentation or by non-disclosure, and he added: “It is quite enough therefore to say that here it was not given in evidence to prove a binding contract between the parties or to contradict or explain, or in any way affect the construction of the policy in question; but it was given in evidence only to shew what their intention was in preparing the policy.” The implication seems clearly to be that it would not have been admissible to affect the construction of the policy. If prior to the passing of the Marine Insurance Act, 1906, the slip was not admissible to explain or in any way affect the construction of the policy, in my judgment it was not admissible for the purpose of affecting the construction of the policy in question in this case. If reinsurers had sought rectification because the policy omitted a term contained in the slip and intended to be incorporated into the subsequent policy, no doubt the Court would have looked at the slip as a document in which the parties had originally recorded their agreement. But that is

not the case here and in my judgment the slip was not admissible as an aid to the construction of the reinsurance contract. I agree that this appeal should be dismissed.’

[909] BP Plc v GE Frankona Reinsurance Ltd [2003] 1 Lloyd’s Rep 537 Cresswell J: [Having referred to, among other cases, ICS v West Bromwich Building Society, his lordship continued:] ‘In New Hampshire Insurance Co v MGN Ltd [1997] 1 LRLR 24 at pp 53–54, Lord Justice Staughton (giving the judgment of the Court) said this: “Secondly, it was submitted that, once a policy has been issued, its terms are conclusive evidence of the contract between the parties unless and until it is altered by the process of rectification. That can happen by agreement of the parties or by order of a Court but not otherwise. And there has been no application for rectification in this case.”

This doctrine is said to be supported by Youell v Bland Welch & Co Ltd (No 1), [1990] 2 Lloyd’s Rep 423 and Punjab National Bank v de Boinville [1992] 1 Lloyd’s Rep 7. But in our opinion those cases are concerned with the situation where a policy has been agreed to by the parties. In those circumstances the policy will, at any rate in the ordinary way, be conclusive evidence of the contract unless and until it has been rectified; the slip cannot be used to add to, explain or contradict the meaning of the policy. That is not this case. Here the issue is whether the policy ever was agreed to. The insurers cannot pre-empt the answer to that question by the unilateral act of issuing it. That was the reasoning of Mr Justice Potter, and we agree with it. In HIH Casualty and General Insurance Ltd v New Hampshire Insurance Co and Others, [2001] 2 Lloyd’s Rep 161, Mr Justice Rix…said at p 179:

“In principle, it would seem to me that it is always admissible to look at a prior contract as part of the matrix or surrounding circumstances of a later contract. I do not see how the parol evidence rule can exclude prior contracts, as distinct from mere negotiations. The difficulty of course is that, where the later contract is intended to supersede the prior contract, it may in the generality of cases simply be useless to try to construe the later contract by reference to the earlier one. Ex hypothesi, the later contract replaces the earlier one and it is likely to be impossible to say that the parties have not wished to alter the terms of their earlier bargain. The earlier contract is unlikely therefore to be of much, if any, assistance. Where the later contract is identical, its construction can stand on its own feet, and in any event its construction should be undertaken primarily by reference to its own overall terms. Where the later contract differs from the earlier contract, prima facie the difference is a deliberate decision to depart from the earlier wording, which again provides no assistance. Therefore a cautious and sceptical approach to finding any assistance in the earlier contract seems to me to be a sound principle. What I doubt, however, is that such a principle can be elevated into a conclusive rule of law. Where, however, it is not even common ground that the later contract is intended to supersede the earlier contract, I do not see how it can ever be permissible to exclude reference to the earlier contract. I do not see how the relationship of the two contracts can be decided without considering both of them. In essence there are, it seems to me, three possibilities. Either the later contract is intended to supersede the earlier, in which case the above principles apply. Or, the later contract is intended to live together with the earlier contract, to the extent that that is possible, but where that is not possible it may well be proper to regard the later contract as superseding the earlier. Or the later contract is intended to be incorporated into the earlier contract, in which case it is prima facie the second contract which may have to give way to the first in the event of inconsistency. I doubt that it is in any event possible to be dogmatic about these matters.”

Is the insurance context different? Is the case of a slip followed by a policy a special case? First, it may be said that where a slip is followed by a policy there will usually be an intention to supersede the slip by the policy. That was the situation which was common ground in Youell’s case etc. Secondly, the considerations mentioned by Phillips J [in Youell and Others v Bland Welch & Co Ltd and Others [1990] 2 Lloyd’s Rep 423], such as the fact that slips customarily set out the contract in shorthand in a way that is neither clear nor complete, will in general promote and underline

the inutility of seeking to find in the slip an aid to the construction of the policy. Beyond that, however, I am doubtful that it is at all helpful to go.’

[910] Non-Marine Underwriters, Lloyd’s of London v Scalera 2000 SCC 24 (Supreme Court of Canada) Iacobucci, Major and Bastarache JJ: ‘A. General Principles of Insurance Contract Interpretation To begin with, I should like to discuss briefly several principles that are relevant to the interpretation of the insurance policy in question. While these principles are merely interpretive aids that cannot decide any issues by themselves, they are nonetheless helpful when interpreting provisions of an insurance contract. (i) The General Purpose of Insurance It is important to keep in mind the underlying economic rationale for insurance. C Brown and J Menezes, Insurance Law in Canada (2nd edn 1991), state this point well at pp 125–26: “Insurance is a mechanism for transferring fortuitous contingent risks. Losses that are neither fortuitous nor contingent cannot economically be transferred because the premium would have to be greater than the value of the subject matter in order to provide for marketing and adjusting costs and a profit for the insurer. It follows, therefore, that even where the literal working of a policy might appear to cover certain losses, it does not, in fact, do so if (1) the loss is from the inherent nature of the subject matter being insured, or (2) it results from the intentional actions of the insured.”

In other words, insurance usually makes economic sense only where the losses covered are unforeseen or accidental: “The assumptions on which insurance is based are undermined if successful claims arise out of loss which is not fortuitous” (C Brown, Insurance Law in Canada (3rd edn 1997), at p 4). This economic rationale takes on a public

policy flavour where, as here, the acts for which the insured is seeking coverage are socially harmful. It may be undesirable to encourage people to injure others intentionally by indemnifying them from the civil consequences. On the other hand, denying coverage has the undesirable effect of precluding recovery against a judgment-proof defendant, thus perhaps discouraging sexual assault victims from bringing claims. See B Feldthusen, “The Civil Action for Sexual Battery: Therapeutic Jurisprudence?” (1993), 25 Ottawa L Rev 203, at p 233. (ii) Contra Proferentem Since insurance contracts are essentially adhesionary, the standard practice is to construe ambiguities against the insurer: Brisette Estate v Westbury Life Insurance Co, [1992] 3 SCR 87, at p 92; Wigle v Allstate Insurance Co of Canada (1984), 49 OR (2d) 101 (CA), per Cory JA. A corollary of this principle is that “coverage provisions should be construed broadly and exclusion clauses narrowly”: Reid Crowther & Partners Ltd v Simcoe & Erie General Insurance Co, [1993] 1 SCR 252, at p 269; Indemnity Insurance Co of North America v Excel Cleaning Service, [1954] SCR 169, at pp 179–80, per Estey J. Therefore one must always be alert to the unequal bargaining power at work in insurance contracts, and interpret such policies accordingly. (iii) Reasonable Expectations Where a contract is unambiguous, a court should give effect to the clear language, reading the contract as a whole: Brisette Estate, above, at p 92; Parsons v Standard Fire Insurance Co (1880), 5 SCR 233. Where there is ambiguity, this Court has noted “the desirability…of giving effect to the reasonable expectations of the parties”: Reid Crowther, above, at p 269 (citing Brown and Menezes, above at pp 123–31, and Brisette Estate, above)…Estey J stated the point succinctly in Consolidated-Bathurst Export Ltd v Mutual Boiler and Machinery Insurance Co, [1980] 1 SCR 888, at pp 901–2:

“[L]iteral meaning should not be applied where to do so would bring about an unrealistic result or a result which would not be contemplated in the commercial atmosphere in which the insurance was contracted. Where words may bear two constructions, the more reasonable one, that which produces a fair result, must certainly be taken as the interpretation which would promote the intention of the parties. Similarly, an interpretation which defeats the intentions of the parties and their objective in entering into the commercial transaction in the first place should be discarded in favour of an interpretation of the policy which promotes a sensible commercial result…Said another way, the courts should be loath to support a construction which would either enable the insurer to pocket the premium without risk or the insured to achieve a recovery which could neither be sensibly sought nor anticipated at the time of the contract.” ’

Note: The following cases illustrate the ways courts have construed particular words in insurance contracts. English v Western [911] shows the application of the contra proferentem rule where a term of the contract is ambiguous (see also 908 and 911); Dino Services Ltd v Prudential Assurance (912) demonstrates the use of two different techniques in the interpretation of ‘forcible and violent’, one resting on a technical meaning of ‘forcible’ dictated by precedent and the other employing the ordinary meaning of ‘violent’; Young v Sun Alliance & London Insurance (913) illustrates the use of the ejusdem generis rule under which in a phrase where particular words are followed by general words the meaning of the latter is constrained by the former. There follows (from [914]) cases in which the meaning of ‘accident’, which has caused a good deal of difficulty to the courts, is discussed. [911] English v Western [1940] 2 KB 156 (CA) [This case, which was an appeal from a decision by Branson J, turned on the meaning of the phrase ‘member of the assured’s household’ in a motor policy].

Slesser LJ: ‘Branson J has come to the conclusion, “that the words ‘member of the assured’s household’ mean a member of the same household as that of which the assured is a member, just as one speaks of a member of a man’s college, or a member of a man’s club. The words are completely apt to cover that construction. Indeed, to my mind, they seem more apt to cover that construction than any other.” Then the learned judge goes on to give reasons why the limitation has been so framed. But, in my view, it is not right to say that those words are apt to cover that construction in the sense that they are not equally apt to cover the other construction which is contended for here by the plaintiff, namely, that the assured’s household refers to a person capable of having a household, namely, a householder. I think those words are equivocal. I think they are equally capable of either construction: and in the circumstances I feel that the learned judge should have considered what principles of law he ought to have applied to the construction of this policy, as no doubt he would have done had he come to the conclusion that those words were as equivocal as I think they are. If the words be equivocal or ambiguous, then I find no difficulty for myself in ascertaining what is the true principle to be applied. I think that the doctrine generally known as contra proferentes should here be applied. I quote from Macgillivray on Insurance Law, 2nd edn, p 1029, where the authorities are conveniently set out: “If there is any ambiguity in the language used in a policy, it is to be construed more strongly against the party who prepared it, that is in the majority of cases against the company. A policy ought to be so framed that he who runs can read. A party who proffers an instrument cannot be permitted to use ambiguous words in the hope that the other side will understand them in a particular sense, and that the Court which has to construe them will give them a different sense, and therefore, where

the words are ambiguous they ought to be construed in that sense in which a prudent and reasonable man on the other side” — that is the side to whom the policy is proffered — “would understand them.” In my view, if that principle be applied, if those words be ambiguous, one arrives at this result. There is given by the opening words of clause 5A a general indemnity to the assured in respect of passengers; and if the underwriters cannot rely upon these words in the exception as necessarily including the household in the sense which Branson J has indicated, namely, that the assured is one member of the same household which includes his sister, then I think they are not entitled to adopt that favourable construction in order to exclude a construction which is said by the plaintiff to be the proper construction, namely, that this clause 5A(a) and (b) has no relation to his case at all, because he was not at any material time a householder, and had not a household. The exception, therefore, must be ruled out in his case, and the general words of liability apply. That seems to me to state the principles on which the construction of an ambiguous document should be dealt with in favour of the proferee. The result is, I come to the conclusion that Branson J was wrong, that the appeal should be allowed; and that judgment in this case should be entered for the plaintiff.’

Notes: 1. In the Judicial Committee of the Privy Council, Lord Hope has stated that, ‘it is not the function of the court, when construing a document, to search for an ambiguity. Nor should the rules which exist to resolve ambiguities be invoked in order to create an ambiguity which, according to the ordinary meaning of the words, is not there. So the starting point is to examine the words used in order to see whether they

are clear and unambiguous.’ (Melanesian Mission Trust Board v Australian Mutual Provident Society [1997] 2 EGLR 128 (PC)) 2. In case in Saskatchewan, Habrinsky J dismissed the notion that an insurer has a duty to explain ambiguous terms as ‘prepostorous’: ‘If the plaintiffs in reality found certain terms to be ambiguous it was incumbent upon them to make inquiries.’ (Saskatchewan Crop Insurance Corp v Greba (1997), 154 Sask R 289 (Saskatchewan Court of Queen’s Bench), 314). Of course, although there may be no duty on the insurer to explain the terms, the consequence of failing to do so could be that the courts construe the policy in a way that was unintended. ‘the insurance company which prepares these documents is bound to make their meaning as clear as possible, and, if there is any ambiguity in the document, it does not lie in the mouth of the company, who may have been receiving premiums under it for years, to insist on that construction of an ambiguous clause which is in their favour.’ (In the Matter of an Arbitration between Etherington and the Lancashire and Yorshire Accident Insurance Co [1909] 1 KB 591 (CA), Farewell LJ)

[912] Dino Services Ltd v Prudential Assurance Co Ltd [1989] 1 Lloyd’s Rep 379 (CA) [The owner of a car repair business took out a policy with Prudential covering, among other things, property on the insured premises that was lost or damaged as the result of theft following an entry or exit by ‘forcible and violent means’. One evening, the

owner drove to a public house where he left his car overnight with the keys to the premises in the glove compartment. The car was stolen and later it was discovered that the premises had been unlawfully entered by means of the keys and property stolen. Pain J’s decision at first instance was to hold the Prudential liable. This was reversed on appeal.] Kerr LJ: ‘…I think the reason why the insurers, understandably, accept that an application of minimal force is sufficient to satisfy the word “forcible” derives from the later of two decisions of this Court given as long ago as 1899 and 1920, to which I shall come in a moment. In itself, this technical interpretation of the word “forcible” appears surprising. Until I saw the 1920 decision it certainly surprised me. It seems to imply that if I use my own house key to let myself into my house, I effect an entry by forcible means. From the first of those two cases it is clear that Lord Russell of Killowen, Chief Justice, would not have accepted that as having been the meaning of the word “forcible” in a similar context. But it is equally clear, at any rate as from 1920, that by reason of the later decision, and in particular of what Lord Justice Atkin said in that case, the ordinary action of turning the knob of a door, or turning a key so as to open a lock, has been taken to satisfy the term “forcible” in this context. So the issue in the present case turns on the effect of the additional word “violent”. …The word “violent” is an ordinary English word, which here appears in a common commercial document. It seems to me that there is no reason why its meaning should be in any way different from what any ordinary person would understand. At first sight I therefore conclude that there should be no need to resort either to a dictionary, or to authorities, to interpret this word; nor to the rule that, this

being an insurers’ document, it must be construed against them. On that basis I would take the ordinary meaning of the word “violent” in this context to be that it is intended to convey that the use of some force to effect entry, which may be minimal, such as the turning of a key in a lock or the turning of a door handle, is accentuated or accompanied by some physical act which can properly be described as violent in its nature or character. An obvious picture that springs to mind is the breaking down of a door or the forcing open of a window, which would be acts of violence directed to the fabric of the premises to effect entry. Or there might be violence to person, such as knocking down someone who seeks to prevent entry, irrespective of whatever may be contained within par. (b) of that part of the cover. Accordingly, on that basis I would not consider for one moment that the ordinary meaning of the phrase “entry to premises by forcible and violent means” can be applied to the action of moving the lever of a lock into its open position by means of its proper key and then turning a knob or pushing the door open to go inside. That would be “forcible” in the sense which I have explained, as is conceded on the authorities. But there would be nothing violent about it at all. That would be my impression. However, Mr Deby [counsel for the plaintiff], who has said everything that could possibly be said, does not accept that approach. He obviously cannot. He stresses the fact that the keys were stolen, and he says that “violent” is a term which characterises the unlawfulness of the act, relying in particular on one short passage in one of the cases to which I shall come. So what he says in effect is that “forcible and violent” is to be equated with “forcible and unlawful” in relation to the means of entry. Unless constrained by authority, which I would be astonished to find, I cannot accept that submission for one moment. I say that for two reasons. First, “violent” as an ordinary word obviously has a different meaning from

“unlawful” or any similar word such as “illegal”. Violence is often unlawful, but not always or necessarily so. For instance, if I break down my own door because I have lost my key, I do something violent but nothing unlawful. On the other hand, a forcible entry which is unlawful is not necessarily one which is effected by violent means. There may be unlawfulness in which violence plays a part — that is what is covered by this provision — or there may be unlawfulness without anything which can be described as violence, and in my view that would not be covered. The second reason why I would not accept Mr Deby’s submission, even if one dictionary meaning of “violent” is “unlawful” as referred to in the judgment to which I come later, is that “unlawful” cannot have been the intended meaning here, because the phrase “by forcible and violent means” occurs in a context which assumes a state of unlawfulness, since we are concerned with “theft or attempted theft” involving entry by the means referred to. Accordingly, I have no doubt that Mr Deby’s valiant attempt to equate “violent” with “unlawfulness “must be rejected, unless astonishingly there were to be any authority binding upon this court which compels its acceptance… [Mr Deby] asks rhetorically: if “violent” has its ordinary meaning, as I think it has, then why use the word “forcible” at all, since “violent” would include the concept of “forcible “? I can see that would be so. The reason why the word “forcible” is there is no doubt because it has an old history and one knows that insurance polices, like other standard business documents, very often do not have their wording changed even when it might be logical to do so. I regret that I cannot attach any weight to either of these submissions. Mr Deby finally says, in my view entirely reasonably, that this is a business document which to the ordinary person would convey that clause 1(a) is intended to cover against burglary, and clause 1(b) against robbery, and that Mr Nash would be amazed to find that on the facts of this case he

was uninsured. I agree and have every sympathy with Mr Nash. Since it is now accepted that he took reasonable precautions and this is an exceptional and novel point, and an important one for insurers generally, I would personally hope that this might be regarded as a deserving case for an ex gratia payment. But, having to construe the policy as I must, I have no doubt that it cannot be construed in the way in which the learned Judge construed it, and accordingly I would allow this appeal.’

[913] Young v Sun Alliance & London Insurance Ltd [1976] 2 Lloyd’s Rep 189 (CA), 191 [The claims was for damage to the ground floor of a house caused by the seepage of water from an underground watercourse. The relevant policy provided cover for loss or destruction or damage caused by ‘storm, tempest or flood…’ The insurer’s rejection of the claim was upheld by the court]. Shaw LJ: ‘…it seems apparent that what the policy was intending to cover, whatever may be the colloquial use of the word “flood” in common parlance, were three forms of natural phenomena which were related not only by the fact that they were natural but also that they were unusual manifestations, certainly of those phenomena: that is to say, “storm” meant rain accompanied by strong wind; ‘tempest’ denoted an even more violent storm; and “flood” was not something which came about by seepage or by trickling or dripping from some natural source, but involved “a large movement, an irruption of water”, as one of the definitions in the Oxford Dictionary puts it. The slow movement of water, which can often be detected so that the loss threatened can be limited, is very different from the

sudden onset of water where nothing effective can be done to prevent the loss, for it happens too quickly. It is because the word “flood” occurs in the context it does, that I have come to the conclusion that one must go back to first impressions, namely, that it is used there in the limited rather than the wider sense; that it means something which is a natural phenomenon which has some element of violence, suddenness or largeness about it.’

Lawton LJ: ‘This appeal raises a semantic problem which has troubled many philosophers for centuries, and it can, I think, be expressed in the aphorism that an elephant is difficult to define but easy to recognise. I find difficulty in defining the word “flood” as used in this policy; I have no difficulty in looking at the evidence in this case and coming to the conclusion, as I do, that the water in the lavatory was not a flood within the meaning…of this policy. Mr Day pointed out to the Court that the phrase in the policy is “Storm, tempest or flood”, and that the word “flood” is used as a word in ordinary English usage to cover a situation which may be very different from the situations to which the words “flooded” or “flooding” are appropriate. I agree. It is not without relevance that para 9, the next paragraph in the policy, refers to the “Escape of water from or frost damage to any water, drainage or heating installation”. So “flood” is something different for the purposes of this policy from an “escape of water”. I agree with Lord Justice Shaw that the essence of “flood” in ordinary English is some abnormal, violent situation. It may not necessarily have to be sudden, but it does, in my judgment, have to be violent and abnormal. This seepage of water through a rise in the water level was not violent, and it was not all that abnormal; it was the sort of incident which householders sometimes have to suffer as a result of “rising damp”. I, too, would dismiss the appeal.’

Note: 1. ‘The fact that the insurer chooses to apply the words in a particular way cannot govern their meaning. For sensible public relations reasons it may decide not to enforce the rights to which it is strictly entitled.’ (Hayward v Norwich Union Insurance Ltd [2001] 1 All ER (Comm) 545 (CA), per Peter Gibson LJ) 2. Lord Denning MR once remarked, ‘It is a mistake for a lawyer to attempt a definition of ordinary words and substitute other words for them. The best way is to take the words in their ordinary sense and apply them to the fact.’ (Starfire Diamond Rings Ltd v Angel [1962] 2 Lloyd’s Rep 217 at 219). However, where a word has been used in a technical sense it will be given that meaning. In Grundy (Teddington) Ltd v Fulton [1981] 2 Lloyd’s Rep 666 (affirmed [1983] 1 Lloyd’s Rep 16), at issue was the meaning of ‘theft’ in a burglary policy. StuartSmith J said: ‘[Counsel for the plaintiffs]… contends that the word “theft” in the policy should not be interpreted in the strict sense of the criminal law but should be understood as commercial men would understand it…In my view, in this policy with which I am now concerned, theft must be given the same meaning as in the criminal law’. See, R Leng, “The Scope of ‘Theft’ in Insurance” (1991) 1 Insur L & P 16; A McGee, “‘Forcible and Violent’ Means of Entry’ (1991) 1 Insur L & P 36; M

Wasik, “Definitions of Crime in Insurance Contracts” [1986] JBL 45. If the policy defines a word, that definition will be applied: Re George and Goldsmiths and General Burglary Insurance Association Ltd [1899] 1 QB 595, CA, in which the policy expressly defined ‘burglary’ and ‘theft’. 3. In Kish v Insurance Company of North America 883 P 2d 308 (Supreme Court of Washington, 1994), the insurer was not held liable on a policy that covered damage by rain but not by flooding after the insured’s home was flooded as a result of excessive rain. The court took the view that ‘an average insurance purchaser’ would regard flood as including a rain-induced flood. The homeowners knew they lived on a floodplain and that flood cover would be excluded from their insurance. Likewise, the insurers did not anticipate providing cover for flooding. [914] Dhak v Insurance Company of North America (UK) Ltd [1996] 5 Re LR 83 (CA) [In May and June 1986 Mrs Dhak, a hospital ward sister, suffered severe back pain as a result of lifting a heavy patient. To relieve the pain she began drinking heavily. She died in October 1986 of acute alcoholism and misadventure. Mr Dhak claimed on a personal accident policy that covered ‘Bodily injury resulting in Death…caused directly or indirectly by

the accident.’At first instance it was held that the insurers were not liable on the ground, among other things, that she must have appreciated the danger of drinking the large amount of alcohol that she consumed, that the immediate cause of death was the inhalation of vomit, which was a danger of drinking large quantities of alcohol, and that there was no bodily injury resulting in death. The Court of Appeal agreed that the insurers were not liable. Neill LJ, giving a judgment with which Aldous LJ and Sir John Balcombe agreed, began by stating that bodily injury was not confined to external and could include internal injury such as suffered by Mrs Dhak]. Neill LJ: ‘I turn therefore to the most difficult issue in this case. It will be remembered that “bodily injury” was defined in the policy as “bodily injury caused by accidental means”. It was argued on behalf of Mr Dhak that Mrs Dhak’s death was plainly an accident. We were referred to the definition of “accident” given by Lord Macnaghten in Fenton v Thorley & Co Ltd [1903] AC 443 at p 448. “…An unlooked-for mishap or an untoward event which is not expected or designed.” Counsel developed his argument on the following lines: (1) The question to be answered in this case was: did Mrs Dhak die as a result of an accident? English law did not distinguish between an accidental result and accidental means. (2) It was true that in some other jurisdictions the law did draw a distinction between an accidental result and accidental means, but this distinction was not part of

the law of England. The passages in the judgment of Lord Justice Mustill in De Souza v Home and Overseas Insurance Co Ltd [1995] LRLR 453, relied upon by the insurers, were obiter dicta and were not necessary for the decision in that case. (3) The proposition contended for was supported by the decision of the Court of Appeal in Hamlyn v Crown Accidental Insurance Co [1893] 1 QB 750. In that case the policy effected by the plaintiff was to secure compensation in case he sustained: “…any bodily injury caused by violent, accidental, external, and visible means.” The plaintiff, who was a tradesman was standing by the counter in his shop when a customer came in with a child. The child dropped a marble which rolled away on the sloping floor. The plaintiff stooped to pick it up and in doing so wrenched his knee. He was disabled for some time. Counsel drew attention to a passage in the judgment of Lord Esher, MR where, in referring to the movement of the plaintiff to pick up the marble, he said at p 753: “He seems to have done this awkwardly; at all events, in doing it he wrenched his knee, and that did the mischief, and that wrench was the cause of the injury. That that was accidental I cannot doubt.” In addition Counsel drew attention to a sentence in the judgment of Lord Justice Lopes at p 754 where he said: “The cause of the injury was accidental in the sense that the injury was a casualty and unforeseen and unexpected.” In this passage, it was said, Lord Justice Lopes was plainly drawing no distinction between an accidental result and an

accidental cause. In this context we were also referred to a note in vol 25 of Halsbury’s Laws of England at para 576: “If the phrase ‘accidental means’ is used in the policy, it seems that it is synonymous with, or at any rate adds nothing to, the phrase ‘by accident’: see Hamlyn v Crown Accidental Insurance Co.” (4) In his powerful dissenting judgment in Landress v Phoenix Mutual Life Insurance (1934) 54 S Ct 461, Judge Cardozo deplored the attempted distinction between accidental results and accidental means. In an apparent reference to Milton’s Paradise Lost he said at p 463: “The attempted distinction between accidental results and accidental means will plunge this branch of the law into a Serbonian Bog.” A little later he added at p 464: “When a man has died in such a way that his death is spoken of as an accident, he has died because of an accident, and hence by accidental means.” (5) Alternatively, if English law does draw a distinction between accidental results and accidental means, it is then necessary to look at the “proximate cause”, that is, the effective or dominant cause of the injury. Counsel accepted that “proximate cause” did not mean the cause which was the nearest in time to the relevant occurrence, but that which was the effective or dominant cause: see Gray v Barr [1971] 2 QB 554 at 567C. In the present case, it was submitted, the proximate cause was the inhalation of the vomit. The ingestion of alcohol was merely part of the background. (6) The examples given by Chief Justice Gibbs in [Australian Casualty Co Ltd v Frederico (1986) 160 CLR 513] were

instructive. At p 521 he said: “…The words ‘caused by an accident’ naturally refer to the proximate or direct cause of the injury, and not to a cause of the cause, or to the mere occasion of the injury. Thus…if a man while walking stumbles and sprains his ankle, the injury is caused by an accident — the stumbling — and not by the deliberate act of walking. Or a person goes swimming, becomes exhausted and drowns — surely the death is caused by an accident.” The decision of the Court of Appeal in Winspear v The Accident Insurance Co (1880) 6 QBD 42 was also of assistance. In that case the deceased was an epileptic. The policy against accidental injury contained a proviso that the insurance should not extend to any injury caused by or arising from natural disease or weakness or exhaustion consequent upon disease. While crossing a stream near Birmingham the deceased was seized by an epileptic fit and fell down in the stream and was drowned. Lord Coleridge, CJ, in a judgment with which the other members of the Court agreed, said at p 45: “The death was not caused by any natural disease or weakness or exhaustion consequent upon disease, but by the accident of drowning.” (7) It was accepted that “accidental means” did not extend to the case where the proximate cause was the deliberate taking of an appreciated risk. An example of a case involving a calculated risk was provided by the decision of Mr Justice Grant in Candler v London & Lancashire Guarantee and Accident Co (1963) 40 DLR (2d) 408. In that case the insured, to show his nerve to a friend, went out to the patio of his 13th floor hotel suite and sat on the coping round the patio with his feet

drawn up. While trying to balance himself he slipped and fell to his death. The deceased had been drinking. The Judge at p 423 described the deceased’s conduct as foolhardy and attended with the most obvious danger. In the present case, however, Mrs Dhak did not take a calculated risk. The Judge was wrong to conclude that Mrs Dhak must have appreciated that her drinking presented a real danger. There was no evidence to this effect. In any event it was to be remembered that the drinking was to relieve pain and that, whatever the position may have been in the early stages, Mrs Dhak’s judgement would have been seriously affected at the crucial time when her intoxication became dangerous. (8) The Judge was wrong to rely on the principle that “a man is taken to intend the natural consequences of his acts”. As Judge Edgar Fay recognised in Marcel Beller Ltd v Hayden [1978] 1 QB 694 at p 704 the law did not require the application of an objective test of risk running. Furthermore, this view of the law was supported by a passage in the judgment of Samuels JA in National and General Insurance Co v Chick [1984] 2 NSWLR 86 where he said at p 103D: “I do not perceive the relevance of invoking the somewhat dubious principle that a man must be taken to intend the ordinary consequence of his acts.” These arguments were put forward most clearly and cogently. I have also taken account of the fact that, on Mr Dhak’s uncontradicted evidence, Mrs Dhak was looking forward to her return to work. In ordinary language it could well be said that Mrs Dhak’s death was indeed a tragic accident. I have come to the conclusion, however, that it has not been established that the bodily injury to Mrs Dhak was “caused by accidental means” within the meaning of the

policy. In reaching this conclusion I have been persuaded that the words “caused by accidental means” are a clear indication that it is the cause of the injury to which the Court must direct its attention. I can turn at once to the judgment of Lord Justice Mustill in De Souza. At p 458 of the report Lord Justice Mustill adopted as representing his own opinion the summary of the law set out in Welford on Accident Insurance (1st edn) (1923) at pp 295–96 and 299: “The word “accident” involves the idea of something fortuitous and unexpected, as opposed to something proceeding from natural causes; and injury caused by accident is to be regarded as the antithesis to bodily infirmity by disease in the ordinary course of events. An injury is caused by accident in the following cases, namely: (1) Where the injury is the natural result of a fortuitous and unexpected cause, as, for instance, where the assured is run over by a train, or thrown from his horse whilst hunting, or injured by a fall, whether through slipping on a step or otherwise; or where the assured is poisoned by mistake, or is suffocated by the smoke of a house on fire or by an escape of gas, or is drowned whilst bathing. In this case the element of accident manifests itself in the cause of the injury. (2) Where the injury is the fortuitous or unexpected result of a natural cause, as, for instance, where a person lifts a heavy burden in the ordinary course of business and injures his spine, or stoops down to pick up a marble and breaks a ligament in his knee, or scratches his leg with his nail whilst putting on a stocking, or ruptures himself whilst playing golf. In this case the element of accident manifests itself, not in the cause, but in its result.”

On the other hand, an injury is not caused by accident when it is the natural result of a natural cause as, for instance, where a person is exposed in the ordinary course of his business to the heat of a tropical sun and in consequence suffers from sunstroke, or where a person with a weak heart injures it by running to catch a train, or by some other intentional act involving violent physical exertion. In this case the element of accident is broadly speaking absent, since the cause is one which comes into operation in the ordinary course of events, and is calculated, within the ordinary experience of mankind, to produce the result which it has in fact produced. In considering whether an injury is caused by accident, it is necessary to take into consideration the circumstances in which the injury is received. Lord Justice Mustill then referred to the examples given by Mr Welford and a little later continued with the quotation: “The same principles apply where the injury is the result, not of natural causes, but of the intervention of human agency. Two cases have to be distinguished, namely: — (1) Where the injury is caused by the act of a third person… (2) Where the injury is caused by the act of the assured himself. An injury may be caused by accident within the meaning of the policy, although it is caused by the act of the assured. The following cases must be distinguished, namely:… (ii) An injury which is the natural and direct consequence of an act deliberately done by the assured is not caused by accident. A man must be taken to intend the ordinary consequences of his acts, and the fact that he did not foresee the particular consequence or expect the particular injury does not make the injury accidental if, in the circumstances it was the natural and direct consequence of what he did, without the

intervention of any fortuitous cause. Thus, if physical exertion, deliberately intended, such as, for instance, running to catch a train, throws a strain upon his heart at a time when it is in a weak and unhealthy condition, in consequence of which the assured dies, his death is not to be regarded as accidental merely because the assured did not know his condition and therefore did not foresee the effect, provided that it was the natural and direct consequence of a strain being put upon a heart in that condition…” I am unable to accept the submission that Lord Justice Mustill’s summary of the law was obiter. The judgment, with which the other members of the Court of Appeal agreed, was given in the context of a claim by the wife of the insured who had been on holiday in Torremolinos where he sustained heat stroke by reason of excessive exposure to the sun and subsequently died. Lord Justice Mustill’s examination of the principles to be applied and of the relevant authorities was directed to dealing with the question whether the insured had sustained “accidental bodily injury” within the meaning of his insurance policy. At p 463, col 1 of the report Lord Justice Mustill said: “Did Mr De Souza suffer an injury? I cannot see that he did. To my mind he unfortunately became ill and died. Where was the element of accident in his illness? The plaintiff has never identified what the accident was, or when it happened. So far as we know there was normal sun, normal heat, and normal exposure to them, which for some reason sadly led to Mr De Souza’s death.” In the course of the argument we were referred to a number of cases on “accidental” injuries decided not only in this country but also in Australia, Canada, the United States and

New Zealand. Some of the decisions are impossible to reconcile. In a number of the Canadian decisions the distinction between accidental means and accidental results has been rejected. The conflicting authorities were considered by Mr Justice Nunn in his judgment in Tracy-Gould v Maritime Life Assurance Co (1992) 89 DLR (4th) 726. At p 732 Mr Justice Nunn concluded that the distinction between “accidental bodily injury” and “bodily injury caused by an accident” was not a real distinction. In my judgment, however, whatever the position may be in some other jurisdictions, the terms of this policy require a Court in this country to concentrate on the cause of the injury and to enquire whether the injury was caused by accidental means. Furthermore, this approach is consistent with a number of the Commonwealth cases to which we were referred including the decision of the Court of Appeal in New Zealand in Long v Colonial Mutual Life Assurance Ltd [1931] NZLR 528 at p 538. It will be remembered that it was argued on behalf of Mr Dhak that the decision of the Court of Appeal in Hamlyn v Crown Accidental Insurance Co supported the proposition that English law drew no distinction between an accidental result and an accidental cause. I have come to the conclusion, however, that the judgments of Lord Esher MR and Lord Justice A L Smith do not support this argument. The policy under consideration included the words — “…any bodily injury caused by violent, accidental, external, and visible means.” Lord Esher at p 753 referred to — “…the cause of the injury [and then considered]…was the cause of the injury something violent?”

Later he added: “…Because the cause of the injury was not internal it must have been ‘external’.” It is clear that he was concentrating on the word “cause”. The judgment of Lord Justice AL Smith is even more explicit. At p 755 he said: “By what means was the plaintiff injured and his knee put out? There cannot be a question that the means were violent. They were also accidental, for getting into the particular position in which the injury could happen was not done on purpose. Then, were they external? I think the word must be understood as meaning the opposite of internal. The means by which the injury was caused were the stooping on the part of the plaintiff and his grabbing at the marble to pick it up…” I would therefore reject Mr Spencer’s first argument. I turn to his argument on proximate cause. It was common ground between Counsel that a proximate cause meant the effective or dominant cause. The point at issue was the application of the law to the facts. The submission on behalf of Mr Dhak was that the excessive intake of alcohol was a part of the background but not the effective cause of the injury. In my judgment, however, the correct approach to the question of cause in this case is to adopt the analysis approved by Lord Justice Mustill in De Souza. In addition one should consider whether the insured took a calculated risk. I would put the matter as follows. Where an insured embarks deliberately on a course of conduct which leads to some bodily injury one has to consider these questions: (a) Did the insured intend to inflict some bodily injury to himself? (b) Did the insured take a

calculated risk that if he continued with that course of conduct he might sustain some bodily injury? (c) Was some bodily injury the natural and direct consequence of the course of conduct? (d) Did some fortuitous cause intervene? In this case there is no suggestion whatever that Mrs Dhak intended any bodily injury to herself. One has therefore to examine the other three questions. At the same time one must take account of all the circumstances including the state of knowledge or presumed state of knowledge of the insured. In considering what could be foreseen one must apply the standard of foresight of the reasonable person with the attributes of the insured. It was strongly argued on behalf of Mr Dhak that the inhalation of vomit was unforeseen and unforeseeable. I have considered this argument with the greatest of care but I have come to the conclusion that the Judge was justified in finding that Mrs Dhak must have been well aware of the consequences and dangers of drinking alcohol to excess and that she must be taken to have foreseen what might happen in the event of someone drinking to excess. She was a ward sister with many years of experience as a nurse. The Judge found as a fact that Mrs Dhak must have drunk at least the contents of a bottle of gin over a relatively short period. I am satisfied that there must have been a point at which she would have realised that any further drinking would be dangerous and that vital bodily functions might be impaired or interrupted. As I said at the outset of this judgment one feels the greatest sympathy for Mr Dhak at his tragic loss. I feel quite unable to say, however, that Mrs Dhak’s injury and death were the result of some fortuitous cause. It was the direct consequence of her drinking to excess. Indeed, I feel bound to say that for someone with her knowledge and experience she must be regarded as having taken a calculated risk of sustaining some bodily injury.

For these reasons I would dismiss this appeal. [Aldous LJ and Sir John Balcombe concurred.]’

[915] Estate of Wade v Continental Insurance Co 514 F 2d 304 (US Court of Appeals, 8th Cir, 1975) [Mrs Wade had been assaulted by her husband, Mr Wade, several times. On this occasion, she said, ‘If I had a gun I’d shoot you.’ He went to another room, got a gun, loaded it and handed it to her, telling her to go ahead and shoot. She did and Mr Wade was killed]. Lay, Circuit Judge: ‘Iowa follows the general rule that the determination whether an injury is accidental must be made from the point of view of the insured and what he intended or should reasonably have expected… “[I]f the insured does a voluntary act, the natural and usual, and to be expected result of which is to bring injury upon himself, then a death so occurring is not an accident. But if the insured does a voluntary act, without knowledge or reasonable expectation that the result thereof will be to bring injury upon himself from which death may follow, then a bodily injury resulting in death is caused by an accident.”

Continental Cas Co v Jackson, 400 F 2d 285, 288 (8th Cir 1968). If the insured is injured due to the intentional acts of another person, the injury may still be accidental for insurance purposes if the insured could not reasonably have foreseen the extent of danger…[W]e hold that under the circumstances existing here the decedent’s wrongful act does not in itself bar recovery…Notwithstanding the obvious

taunt and defiance shown, there is no evidence on the present record to show that Wade would reasonably foresee that his wife would actually shoot him. Given the prior relationship of the parties, there is no evidence from their conduct to suggest that Wade, even though he impulsively dared his wife to do so, would reasonably foresee that result. According to the testimony credited by the district court, Wade neither threatened his wife’s life nor pointed the gun at her. Although he did strike her somewhat earlier, he had done so many times before and she had never offered violent retaliation. However reprehensible Wade’s conduct may have been there is no evidence to support a finding that the shooting was “according to the usual course of things” or “the natural and usual…result” of handing a previously law-abiding and long-suffering wife a gun, even with a defiant challenge to use it…The general rule is that one has no duty to foresee the criminal conduct to another.’

[916] Candler v The London & Lancashire Guarantee & Accident Co of Canada and Norwich Union Fire Insurance Society Ltd (1963) 40 DLR (2d) 408 (Ontario High Court of Justice) [The insurer was held not liable on an accident policy after the insured fell to his death from a narrow ledge outside the window of a thirteenth-floor room while trying to demonstrate his fearlessness to a friend. There was evidence that he had consumed sufficient alcohol to influence him to undertake the action]. Grant J: ‘“accidental means” is determined…by the foreseeability of the result naturally following from the deceased’s actions. If

the fall from the coping was not an unusual or unexpected incident associated with the deceased’s actions, it cannot be termed as occurring by accidental means…. His statement that he would show he still had nerve is the conclusive evidence that he appreciated the risk involved. If part of the coping had given away or some other unforeseen act had occurred thereby causing him to fall it might well then be held that it was an accident, but there is no room for such a finding…Once the deceased engaged in the dangerous exercises above-described, from which one of the natural and probable consequences might well be a fall to the ground below, even though he felt he could accomplish the fact without falling, it must taken that the mishap was not accidental or caused by accidental means unless there was some other unusual or unexpected occurrence in addition to the voluntary act of the deceased and which could not be reasonably foreseen and which produced the fall, before it can be classed as accidental.’

Notes: 1. See also Gray v Barr, Prudential Assurance Co Ltd (Third Party) [1971] 2 QB 554 (CA) at [1116]. 2. In National & General Insurance Co Ltd v Chick [1984] 2 NSWLR 86 (Court of Appeal, New South Wales), whilst in the company of work colleagues Mr Chick produced gun, which he was licensed to possess. He removed five of the six cartridges, spun the chamber several times and on each occasion told the others whether or not the gun would have fired had he pulled the trigger. He was able to do this because in order to spin the chamber the cylinder, which

held the cartridges, had to be open and this enabled him to see the position of the cartridge. Chick then repeated this action, but this time he held the gun to his head and pulled the trigger. He repeated this three times. Each time he held the gun below a desk in order to check the position of the cartridge. On the third occasion the gun fired and Chick was killed. It was held that this was not Russian Roulette in which, in the view of Samuels JA, the participant ‘voluntarily and deliberately accepts the risk of the occurrence of the result which in fact ensues…[H]e courts the risk of injury or death.’ Instead, Chick’s death was accidental in that ‘the discharge of the revolver, being unforeseen, unexpected and unintended was accidental. The deceased neither desired it nor wished to bring it about. It was not a willed act.’ Samuels JA went on to say: ‘It is not to the point…that it was in fact inevitable that the revolver would fire when the deceased pressed the trigger for the third time, or that he may have been careless in checking the position of the cartridge, or in making an assumption about the working of the weapon which his knowledge did not justify; or, indeed, that a prudent person would not have handled a loaded firearm in this fashion. Rather it is necessary first to ascertain the cause of the injury and then to decide whether that act was, according to the ordinary commonsense meaning of the word, an accident. And that entails an inquiry into what the deceased himself intended, believed or undertook. In

my opinion the injury here was caused by accidental means.’

The court concluded that the death was an accident and the insurers were, therefore, liable because the firing of the pistol was unforeseen, unexpected and unintended by Chick, who believed he could accurately predict when it was safe to fire. Samuels JA saw this case as no different from the situation in which someone, while cleaning what he or she believed to be an unloaded gun, pressed the trigger to test the mechanism and the gun fired, or someone drank poison believing it to be medicine (see Cole v Accident Insurance Co Ltd (1889) 61 LT 227): in each of these examples the cause of death was the firing of the gun and the drinking of the poison neither of which the deceased intended to do. 3. In JJ Lloyd Instruments Ltd v Northern Star Insurance Co Ltd (The “Miss Jay Jay”) [1987] 1 Lloyd’s Rep 32 (Court of Appeal), Lawton LJ said that an event which was ‘a readily foreseeable risk’ might still amount to an accident as long as it was not ‘bound to occur’. In that case, the insured did not intend the loss and it was unexpected because, while the rough conditions at sea were expected, the effect of such seas on the defectively designed boat was unexpected.

9.3

The Doctrine of Expectations in the USA

Reasonable

As in England, the US courts have long subscribed to the method of construction that looks to the plain meaning of the words used and that rejects the idea that the courts can modify the terms of the contract. Only if the wording is obscure can any ambiguity be construed against the party relying on it (eg JA Brundage Plumbing and Roto-Rooter Inc v Massachusetts Bay Insurance Co 818 F Supp 553 (US District Court, Western District, New York, 1993). ‘In choosing among the reasonable meanings of a promise or agreement or a term thereof, that meaning is generally preferred which operates against the party who supplies the words or from whom a writing otherwise proceeds.’ (Restatement, Contracts (2d) § 206)

[917] California Civil Code ‘1635 All contracts, whether public or private, are to be interpreted by the same rules, except as otherwise provided by this Code. 1636 A contract must be so interpreted as to give effect to the mutual intention of the parties as it existed at the time of contracting, so far as the same is ascertainable and lawful. … 1638 The language of a contract is to govern its interpretation, if the language is clear and explicit, and does

not involve an absurdity. … 1641 The whole of a contract is to be taken together, so as to give effect to every part, if reasonably practicable, each clause helping to interpret the other. … 1644 The words of a contract are to be understood in their ordinary and popular sense, rather than according to their strict legal meaning; unless used by the parties in a technical sense, or unless a special meaning is given to them by usage, in which case the latter must be followed. 1645 Technical words are to be interpreted as usually understood by persons in the profession or business to which they relate, unless clearly used in a different sense. … 1649 If the terms of a promise are in any respect ambiguous or uncertain, it must be interpreted in the sense in which the promisor believed, at the time of making it, that the promisee understood it. … 1653 Words in a contract which are wholly inconsistent with its nature, or with the main intention of the parties, are to be rejected. 1654 In cases of uncertainty not removed by the preceding rules, the language of a contract should be interpreted most strongly against the party who caused the uncertainty to exist.’

[918] Montrose Chemical Corp v Admiral Ins Co 42 Cal Rptr2d 324 (Supreme Court of California, 1995) Lucas CJ: ‘Insurance policies are contracts and, therefore, are governed in the first instance by the rules of construction applicable to contracts. Under statutory rules of contract interpretation, the mutual intention of the parties at the time the contract is formed governs its interpretation. (Civ Code, §1636.) Such intent is to be inferred, if possible, solely from the written provisions of the contract. (Id, § 1639.) The “clear and explicit” meaning of these provisions, interpreted in their “ordinary and popular sense,” controls judicial interpretation unless “used by the parties in a technical sense, or unless a special meaning is given to them by usage.” (Id, §§ 1638, 1644.) If the meaning a layperson would ascribe to the language of a contract of insurance is clear and unambiguous, a court will apply that meaning… In contrast, “[i]f there is ambiguity…it is resolved by interpreting the ambiguous provisions in the sense the promisor (ie, the insurer) believed the promisee understood them at the time of formation. (Civ Code, §1649.) If application of this rule does not eliminate the ambiguity, ambiguous language is construed against the party who caused the uncertainty to exist.” (Id, § 1654.) This rule, as applied to a promise of coverage in an insurance policy, protects not the subjective beliefs of the insurer but, rather, “the objectively reasonable expectations of the insured.” [AIU Ins Co v Superior Court (1990) 51 Cal 3d 807, 822] Only if this rule does not resolve the ambiguity do we then resolve it against the insurer… We explained further in [AIU Ins Co v Superior Court (1990) 51 Cal 3d 807, 822] that “[i]n the insurance context, we generally resolve ambiguities in favor of

coverage”…“Similarly, we generally interpret the coverage clauses of insurance policies broadly, in order to protect the objectively reasonable expectations of the insured…These rules stem from the fact that the insurer typically drafts policy language, leaving the insured little or no meaningful opportunity or ability to bargain for modifications…Because the insurer writes the policy, it is held ‘responsible’ for ambiguous policy language, which is therefore construed in favor of coverage.” Is the language of Admiral’s contracts of insurance here in issue “clear and explicit,” and thus controlling…— or is it ambiguous, requiring us to interpret the coverage clauses broadly in order to protect the objectively reasonable expectations of Montrose, the insured?’

[919] State Bancorp Inc v US Fidelity and Guar Ins Co 483 SE2d 228 (West Virginia Supreme Court of Appeals, 1997) Recht J: ‘This Court is also mindful that “[w]here the provisions of an insurance policy contract are clear and unambiguous they are not subject to judicial construction or interpretation, but full effect will be given to the plain meaning intended.”… However, if the language in an insurance policy is ambiguous, then the doctrine of reasonable expectations applies: “With respect to insurance contracts, the doctrine of reasonable expectations is that the objectively reasonable expectations of applicants and intended beneficiaries regarding the terms of insurance contracts will be honored even though painstaking study of the policy provisions would have negated those expectations.”… National Mutual Ins Co v McMahon & Sons Inc, 177 WVa 734, 356 SE2d 488 (1987). (The doctrine of reasonable expectations only applies in West Virginia when the policy

language in ambiguous). Lastly, “[w]here the policy language involved is exclusionary, it will be strictly construed against the insurer in order that the purpose of providing indemnity not be defeated.…[ibid]”…’

Construing a contract of insurance according to its plain and ordinary meaning implicitly assumes both parties have equal bargaining power and the policy reflects their intentions (see [917] and [918]). Yet, insurance contracts are contracts of adhesion, that is their terms are not a matter for negotiation but are offered by the insurer to the prospective insured on a take-it-or-leave-it basis (see [921]). Led by Professor (later Judge) Keeton, there has been a move among some judges and academics to apply an approach that interprets insurance contracts according to the reasonable expectations of the insured and regardless of the wording. That such a fundamental shift has gained some support among the judiciary in the US may indicate a greater willingness to recognise the distinctiveness of certain types of contracts and to acknowledge the significant public policy issues that underlie many modern insurance contracts. Professor Keeton suggested (see [920]) that, ‘courts began to clearly enunciate a new principle upon which to justify holdings that claimants are entitled to rights at variance with insurance contract provisions even when the applicable insurance policy provisions are not ambiguous.’ (at 631) He argued that this doctrine emerged from an earlier practice of courts declaring ambiguity in spite of the meaning of

the policy being clear. That approach had created ‘an impression of unprincipled judicial prejudice against insurers and the insurance industry, but also… confusion and uncertainty about the nature and extent of judicial regulation of contract terms.’ (at 632) In the 1960s a shift, therefore, took place whereby judges began to base their decisions on efforts ‘to honor or protect the reasonable expectations of policyholders.’ (at 632) [920] RE Keeton & AI Widiss, Insurance Law: A Guide to Fundamental Principles, Legal Doctrines, and Commercial Practices (St Paul, West Publishing, 1988) ‘In general, courts will protect the reasonable expectations of applicants, insureds, and intended beneficiaries regarding the coverage afforded by insurance contracts even though a careful examination of the policy provisions indicates that such expectations are contrary to the expressed intention of the insurer… The situations in which courts conclude that an application of the reasonable expectations principle is justified often involve circumstances which indicate that there was either some element of unconsionability in the conduct of the insurer or some detrimental reliance on the part of the insured… [Professor Keeton goes on to characterise as unconscionable policies that provide very little coverage, particularly where the premiums were out of line with what might be expected for that level of coverage.] There are several pragmatic reasons why coverage limitations that conflict with reasonable expectations ought

not to be enforced even when the limitations are both explicit and unambiguous in policy forms. First, insurance contracts are set forth in insurance policies that typically are long, complicated documents which insurers know policyholders ordinarily will not even read and certainly will not carefully study. Relatively few policyholders ever examine their insurance policies with the care that would be required for even moderately detailed understanding of coverage limitations. Moreover, many insurance contracts cannot be understood without detailed analysis, and often not even an extended consideration of the terms would fully apprise an insured of the precise scope of coverage and the meaning of the limitations or restrictions set forth in a particular insurance policy. Caveat. It should be noted, however, that many insurers have revised both the format and the wording of insurance policies with a view to making them significantly more understandable to the consumer. The import of these newer insurance documents — which are typically referred to by characterisations such as “plain language,” “plain talk,” or “easy read” forms — is yet to be considered by the courts in most jurisdictions. Secondly, the marketing approaches employed for most kinds of insurance ordinarily do not even allow a purchaser to examine a copy of an insurance policy until after the contract has been completed. In life insurance transactions, for example, the purchaser usually does not see the insurance policy terms until after the application has been submitted, the first premium has been paid, the insurance company has decided to approve the application, and the company has issued the policy. This often means a delay of weeks, or even months, between submitting an application and receiving the insurance policy. In many situations, such delays undoubtedly contributes a policyholder’s disinclination to read the insurance policy carefully or even to read it at all. Although the time which elapses before a

purchaser receives a copy of the insurance policy is usually not as long in regard to other types of insurance the marketing transaction for most coverages is structured in way that does in fact defer access to the coverage terms until after the contract has been consummated. In this context, the justification for concluding that a policyholder’s reasonable expectations should be honored is certainly compelling, and especially so when the policy language is difficult to understand or employs a technical vocabulary. Furthermore, even when the language of a policy provision is clearly understandable, the argument still applies unless an insurer can show that a purchaser’s failure to read and understand the contract language establishing coverage limitations was unreasonable. Thirdly, there are many situations in which protection of an insured’s reasonable expectations is viewed as appropriate because it would be unconscionable or unfair to allow an insurer to enforce the limitations or restrictions in the insurance policy. In some instances, courts predicate such decisions, at least in part, on the fact that the insurance policy provision at issue is included in a contract of adhesion.… Fourthly, it is appropriate to protect expectations which result from the marketing practices of the insurer — that is, actual or reasonable expectations which differ from the coverage provisions — that are derived from events or acts which were attributable either to the actions of persons in the field representing the insurer in the marketing transaction or persons at a management center that directs the operations of the insurance company. Furthermore, there are circumstances in which an insured’s reasonable expectations may result from the conduct of the insurance industry as a whole. Fifthly, expectations which result from the way in which the specific insurance coverage at issue is characterised by the insurer — as, for example, a “Blanket Coverage” or a

“Comprehensive Coverage Plan” warrant protection in some circumstances. Similarly, an insured may have reasonable expectations about the scope of coverage as a consequence of the format of the insurance policy which sets forth in large print at the beginning of the policy a broad statement of coverage, even though the policy terms do circumscribe the coverage by limitations and restrictions which appear elsewhere in the form (and which often are not apparent to the typical consumer). Comment In some circumstances, the scope of an insurance coverage should be predicated on the reasonable expectations of an insured even though an insurance policy includes an explicit and unambiguous limitation that could have been discovered by an insured through a comprehensive analysis of the terms. Determinations about (1) whether an insurance policy includes a provision that unambiguously limits or excludes coverage and (2) whether a policyholder could have sufficiently examined an insurance policy so as to discover a relevant clause which limits the coverage, should be factors bearing on decisions about whether the policyholder’s expectations in regard to a matter at issue were reasonable from a lay person’s point of view. However, the scope to be accorded to this approach should be carefully evaluated case-by-case because in many instances there have been, and undoubtedly will continue to be, circumstances in which there is substantial justification for predicating the resolution of a coverage dispute on other considerations and doctrines. This is especially true when it is possible to ascertain the actual expectations of the insured, as well as the insurer.’

Note:

See also, RE Keeton, “Insurance Law Rights at Variance with Policy Provisions” (1970) 83 Harv L Rev 961; MC Rahdert, “Reasonable Expectations Reconsidered” (1986) 18 Connecticut Insurance Law Journal 323; J Stempel, “Unmet Expectations: Undue Restriction of the Reasonable Expectations Approach and the Misleading Mythology of Judicial Role” (1998) 5 Connecticut Insurance Law Journal 181. See StuartSmith LJ’s brief aside in Yorkshire Water Services Ltd v Sun Alliance & London Insurance plc [1997] 2 Lloyd’s Rep 21 (CA) (see [1020]): ‘For the most part these notions which reflect a substantial element of public policy are not part of the principles of construction of contracts under English law…’ [921] J Stempel, ‘Reassessing the “Sophisticated Policyholder” Defense’, (1993) 42 Drake L Rev 807 ‘Of course, the super-adhesive nature of insurance policies does not make them “bad” or legally suspect. Standardised adhesion contracts are probably the majority of contracts in use today and are widely enforced. Courts view standardisation as an inevitable consequence of a mass contracting, consumer-driven, market-oriented economy. Standardisation reduces the time and money spent on contracting and courts generally are receptive to enforcing them so these savings can be realised, so long as the adhesive terms are not unfair. When dealing with insurance policies, courts and commentators are even more solicitous of the benefits derived from standardised terms and adhesion marketing, because they not only lower transaction costs but facilitate risk spreading through

developing a risk pool of policyholders all subject to the same contract language. When focused on these aspects of adhesion, courts construing insurance policies are generally solicitous of insurers. The flip side of the inquiry often leads courts to focus on the policyholder’s dependence on coverage that hinges on an adhesion contract term the policyholder never read, probably could not understand or did not expect, and contained in a document he or she received long after making the insurance commitment. When focused on these traits, courts are more likely to make liberal use of doctrines such as contra proferentum and reasonable expectations and find for policyholders. This tendency is, as expected, more pronounced in close cases and those involving consumer insureds.’

[922] Atwater Creamery Co v Western National Mutual Insurance Co 366 NW2d 271 (Supreme Court, Minnesota, 1985) [Atwater was insured against burglary by Western. Liability under the policy arose if there was ‘evidence of forcible entry’. Thieves gained entry by removing padlocks. It was determined by the police that no employees or ex-employees of Atwater had been involved in the crime. Western denied liability because there were no visible marks of physical damage at the point of entry or exit, as required by the definition of burglary in the policy. Charles H Strehlow, Western’s agent, was certain that he told Atwater about the evidence-of-forcible-entry requirement, although no one at Atwater could recall this. One of the Atwater board members had begun

to read the policy, but stopped because he could not understand it]. Wahl J: [with whom the majority concurred (footnotes omitted)] ‘The definition of burglary in this policy is one used generally in burglary insurance. Courts have construed it in different ways. It has been held ambiguous and construed in favour of coverage in the absence of visible marks of forceable entry or exit. United States Fidelity & Guaranty Co v Woodward, 118 GaApp 591, 164 SE2d 878 (1968). We reject this analysis because we view the definition in the policy as clear and precise. It is not ambiguous. In determining the intent of the parties to the insurance contract, courts have looked to the purpose of the visiblemarks-of-forcible-entry requirement. These purposes are two: to protect insurance companies from fraud by way of “inside jobs” and to encourage insureds to reasonably secure the premises…As long as the theft involved clearly neither an inside job nor the result of a lack of secured premises, some courts have simply held that the definition does not apply…. In the instant case, there is no dispute as to whether Atwater is attempting to defraud Western or whether the Soil Center was properly secured. The trial court found that the premises were secured before the robbery and that the law enforcement investigators had determined that it was not an “inside job.” To enforce the burglary definition literally against the creamery will in no way effectuate either purpose behind the restrictive definition. We are uncomfortable, however, with this analysis given the right of an insurer to limit the risk against which it will indemnify insureds. At least three state courts have held that the definition merely provides for one form of evidence which may be

used to prove a burglary and that, consequently, other evidence of a burglary will suffice to provide coverage. Ferguson v Phoenix Assurance Co of New York, 189 Kan 459, 370 P2d 379 (1962); National Surety Co v Silberberg Bros, 176 SW 97 (Tex Civ App 1915); Rosenthal v American Bonding Co of Baltimore, 124 NYS 905 (NY Sup Ct 1910). The Nebraska Supreme Court recently rejected this argument in Cochran v MFA Mutual Insurance Co, 201 Neb 631, 271 NW2d 331 (1978). The Cochran court held that the definition is not a rule of evidence but is a limit on liability, is unambiguous and is applied literally to the facts of the case at hand. We, too, reject this view of the definition as merely a form of evidence. The policy attempts to comprehensively define burglaries that are covered by it. In essence, this approach ignores the policy definition altogether and substitutes the court’s or the statute’s definition of burglary. This we decline to do, either via the conformity clause or by calling the policy definition merely one form of evidence of a burglary. Some courts and commentators have recognised that the burglary definition at issue in this case constitutes a rather hidden exclusion from coverage. Exclusions in insurance contracts are read narrowly against the insurer. Running through the many court opinions refusing to literally enforce this burglary definition is the concept that the definition is surprisingly restrictive, that no one purchasing something called burglary insurance would expect coverage to exclude skilled burglaries that leave no visible marks of forcible entry or exit. Professor Robert E Keeton, in analysing these and other insurance cases where the results often do not follow from the rules stated, found there to be two general principles underlying many decisions. These principles are the reasonable expectations of the insured and the unconscionability of the clause itself or as applied to the facts of a specific case. Keeton, Insurance Law Rights at Variance with Policy Provisions, 83 Harv L Rev 961 (1970).

Keeton’s article and subsequent book, Basic Text on Insurance Law, (1971), have had significant impact on the construction of insurance contracts. The doctrine of protecting the reasonable expectations of the insured is closely related to the doctrine of contracts of adhesion. Where there is unequal bargaining power between the parties so that one party controls all of the terms and offers the contract on a take-it-or-leave-it basis, the contract will be strictly construed against the party who drafted it. Most courts recognise the great disparity in bargaining power between insurance companies and those who seek insurance. Further, they recognise that, in the majority of cases, a lay person lacks the necessary skills to read and understand insurance policies, which are typically long, set out in very small type and written from a legalistic or insurance expert’s perspective. Finally, courts recognise that people purchase insurance relying on others, the agent or company, to provide a policy that meets their needs. The result of the lack of insurance expertise on the part of insureds and the recognised marketing techniques of insurance companies is that “[t]he objectively reasonable expectations of applicants and intended beneficiaries regarding the terms of insurance contracts will be honored even though painstaking study of the policy provisions would have negated those expectations.” Keeton, 83 Harv L Rev at 967. The traditional approach to construction of insurance contracts is to require some kind of ambiguity in the policy before applying the doctrine of reasonable expectations. Several courts, however, have adopted Keeton’s view that ambiguity ought not be a condition precedent to the application of the reasonable-expectations doctrine. As of 1980, approximately ten states had adopted the newer rule of reasonable expectations regardless of ambiguity. Davenport Peters Co v Royal Globe Insurance Co, 490 FSupp 286, 291 (DMass 1980). Other states, such as

Missouri and North Dakota, have joined the ten since then. Most courts recognize that insureds seldom see the policy until the premium is paid, and even if they try to read it, they do not comprehend it. Few courts require insureds to have minutely examined the policy before relying on the terms they expect it to have and for which they have paid. The burglary definition is a classic example of a policy provision that should be, and has been, interpreted according to the reasonable expectations of the insured. C & J Fertilizer, Inc v Allied Mutual Insurance Co, 227 NW2d 169 (Iowa 1975). C & J Fertilizer involved a burglary definition almost exactly like the one in the instant case as well as a burglary very similar to the Atwater burglary. The court applied the reasonable-expectationsregardless-ofambiguity doctrine, noting that “[t]he most plaintiff might have reasonably anticipated was a policy requirement of visual evidence (abundant here) indicating the burglary was an ‘outside’ not an ‘inside’ job. The exclusion in issue, masking as a definition, makes insurer’s obligation to pay turn on the skill of the burglar, not on the event the parties bargained for: a bona fide third party burglary resulting in loss of plaintiff’s chemicals and equipment.” Id at 177. The burglary in C & J Fertilizer left no visible marks on the exterior of the building, but an interior door was damaged. In the instant case, the facts are very similar except that there was no damage to the interior doors; their padlocks were simply gone. In C & J Fertilizer, the police concluded that an “outside” burglary had occurred. The same is true here. Atwater had a burglary policy with Western for more than 30 years. The creamery relied on Charles Strehlow to procure for it insurance suitable for its needs. There is some factual dispute as to whether Strehlow ever told Poe about the “exclusion,” as Strehlow called it. Even if he had said that there was a visible-marks-of-forcible-entry requirement, Poe could reasonably have thought that it meant that there

must be clear evidence of a burglary. There are, of course, fidelity bonds which cover employee theft. The creamery had such a policy covering director and manager theft. The fidelity company, however, does not undertake to insure against the risk of third-party burglaries. A business that requests and purchases burglary insurance reasonably is seeking coverage for loss from third-party burglaries whether a break-in is accomplished by an inept burglar or by a highly skilled burglar. Two other burglaries had occurred at the Soil Center, for which Atwater had received insurance proceeds under the policy. Poe and the board of the creamery could reasonably have expected the burglary policy to cover this burglary where the police, as well as the trial court, found that it was an “outside job.” The reasonable-expectations doctrine gives the court a standard by which to construe insurance contracts without having to rely on arbitrary rules which do not reflect real-life situations and without having to bend and stretch those rules to do justice in individual cases. As Professor Keeton points out, ambiguity in the language of the contract is not irrelevant under this standard but becomes a factor in determining the reasonable expectations of the insured, along with such factors as whether the insured was told of important, but obscure, conditions or exclusions and whether the particular provision in the contract at issue is an item known by the public generally. The doctrine does not automatically remove from the insured a responsibility to read the policy. It does, however, recognize that in certain instances, such as where major exclusions are hidden in the definitions section, the insured should be held only to reasonable knowledge of the literal terms and conditions. The insured may show what actual expectations he or she had, but the factfinder should determine whether those expectations were reasonable under the circumstances. We have used the reasonable-expectations-of-the-insured analysis to provide coverage where the actual language

interpreted as the insurance company intended would have proscribed coverage. Canadian Universal Insurance Co v Fire Watch, Inc, 258 NW2d 570 (Minn 1977). Western correctly points out that the issue there concerned a special endorsement issued subsequent to the policy which reduced coverage without notice to the insured. While the issue is somewhat different in the instant case, it is not so different that the general concept is made inapplicable. In our view, the reasonable-expectations doctrine does not automatically mandate either pro-insurer or pro-insured results. It does place a burden on insurance companies to communicate coverage and exclusions of policies accurately and clearly. It does require that expectations of coverage by the insured be reasonable under the circumstances. Neither of those requirements seems overly burdensome. Properly used, the doctrine will result in coverage in some cases and in no coverage in others. …We hold that where the technical definition of burglary in a burglary insurance policy is, in effect, an exclusion from coverage, it will not be interpreted so as to defeat the reasonable expectations of the purchaser of the policy. Under the facts and circumstances of this case, Atwater reasonably expected that its burglary insurance policy with Western would cover the burglary that occurred. Our holding requires reversal as to policy coverage.’

Simonett J: [concurring specially] ‘I would not apply the reasonable expectations test in the absence of ambiguity in the policy; but because I believe such ambiguity exists, I concur in the majority opinion to reverse.’

Note:

See (1998) 5 Connecticut Insurance Law Journal 1473 for a collection of essays on this issue. Acceptance of the doctrine of reasonable expectations by the courts in the US has been patchy: some states seem to have adopted it, others have explicitly rejected it. Certainly, it poses a number of difficulties. It seems to sacrifice the certainty of the ordinary meaning approach, although whether that does really deliver certainty is a matter of dispute. It is also unclear what ‘reasonable expectations’ means: what factors should be taken into consideration in determining what an insured’s reasonable expectations are? This lack of clarity may merely create uncertainty and, even though in practice the doctrine is used sparingly, it may encourage an insured to believe the court will rewrite the policy. Nevertheless, this debate does demonstrate the significant role played by public policy considerations in the US insurance law.

10 Causation 10.1 Proximate Cause Rule Insurers are only liable for losses they have agreed to cover, and, therefore, their liability necessarily involves determining what caused a loss. See M Clarke, “Insurance: The Proximate Cause in English law” (1981) 40 CLJ 284. [1001] Dudgeon v Pembroke (1874) LR 9 QB 581 Blackburn J: ‘The ship perished because she went ashore on the coast of Yorkshire. The cause of her going ashore was partly that it was thick weather and she was making for Hull in distress, and partly that she was unmanageable because full of water. The cause of that cause, viz., her being in distress and full of water, was, that when she laboured in the rolling sea she made water; and the cause of her making water was, that when she left London she was not in so strong and staunch a state as she ought to have been.’

[1002] R E Keeton and A I Widiss, Insurance Law: A Guide to Fundamental Principles, Legal Doctrines, and Commercial Practices (St Paul, MN, West Publishing, 1988) at 546 ‘Whenever human experiences extend over a period of time, it is possible to select one point in the sequence of events and consider the situation that existed at that moment from several perspectives: first, focusing on the circumstances existing at that moment as the vantage point from which to analyse the sequence of events which preceded and followed; secondly, focusing on that set of circumstances as a result of what has gone before; and third, focusing on that set of circumstances as a cause of what is yet to come. Even when the focus is clearly stated, however, it is still necessary to be selective about what is described or characterised, because it is humanly impossible to identify every detail. Accordingly, whenever there are questions about causation, the analysis can only focus on some portion of (1) the facts that comprise circumstances which exist at any specific moment, (2) the later events that are treated as its results, and (3) the antecedent events that are treated as its causes. Thus, although insurance policy provisions and the interpretations of these terms sometimes predicate the existence of coverage on distinctions that relate to the elements of the “cause-event-result” trichotomy, unfortunately the analysis is often less than clear because of the lack of any prevailing criteria for selecting from all the existing circumstances those that are relevant to the interpretation and application of the provisions at issue in a given context.’

[1003] Marine Insurance Act 1906

Section 55(1) ‘Subject to the provisions of this Act, and unless the policy otherwise provides, the insurer is liable for any loss proximately caused by a peril insured against, but, subject as aforesaid, he is not liable for any loss which is not proximately caused by a peril insured against.’

[1004] Ionides v The Universal Marine Insurance Co (1863) 14 CB (NS) 259 Willes J: ‘you are not to trouble yourself with distant causes, or to go into a metaphysical distinction between causes efficient and material and causes final; but you are to look exclusively to the proximate and immediate cause of the loss.’

[1005] Reischer v Borwick [1894] 2 QB 548 (CA) [The insured ship was holed by an accidental collision and a temporary repair was effected so it could be towed into a harbour. However, the motion through the sea caused by the towing led the hole to reopen and the ship sank. The insurers were held to be liable on a policy that covered damage caused by a collision but not by perils of the sea]. Lindley LJ: ‘I feel the difficulty of expressing in precise language the distinction between causes which cooperate in producing a given result. When they succeed each other at intervals which can be observed it is comparatively easy to distinguish them and to trace their respective effects; but under other circumstances it may be impossible to do so. It appears to me, however, that an injury to a ship may fairly

be said to cause its loss if, because that injury is or can be repaired, the ship is lost by reason of the existence of that injury — ie, under circumstances which, but for that injury, would not have affected her safety.’

Davey LJ: ‘What is the causa proxima of the damage sustained in this case? The only answer seems to be to be the inrush of water through the hole in the condenser. What made the hole in the condenser? The collision made the hold in the condenser, and the broken condenser was a continuing source of risk and danger. The failure of the attempt to mitigate or stop the damage arising from the breach in the condenser cannot in my opinion be justly described as the cause of the ultimate damage.’

[1006] Leyland Shipping Co Ltd v Norwich Union Fire Insurance Society Ltd [1918] AC 350 (HL) Lord Shaw: ‘My Lords, on 30 January 1915, the Ikaria, bound from South American ports to Havre with a general cargo, was, about 25 miles north-west of Havre, struck by a torpedo fired from a German submarine. She sustained severe injuries; but, assisted by a tug and a mine-sweeper, she succeeded in making the port of Havre. She was then drawing 32 feet forward, the injuries and consequent filling being in the fore part of the vessel: and her depth was too great to permit her entry into the inner harbour. In the outer harbour she was berthed for a time at the Quai d’Escale. There being, however, a fear that she might sink there and so interrupt the traffic of the Red Cross organization at that quay, she was taken to another portion of the harbour. At the latter point, notwithstanding all efforts by pumping and otherwise,

she bumped, broke ‘her back, and sank on the afternoon of 2 February. It is admitted that from the time of her being torpedoed everything was done to save her from the fatal effects of the collision, and that after she entered the harbour her officers were bound to obey the orders of the harbourmaster. The weather was rough, but not severely so. I see no reason whatever to doubt that this happened, as Captain Robertson, in his report of 10 February, states. “It seems evident,” says he, “from the very sudden way in which the forward end of the vessel crumpled up that her structure was so weakened by the terrific force of the explosion that there was no strength left to resist the additional strain imposed on her, firstly, by the great weight of water against the bulkheads and afterwards by the bursting strain of the cargo as it swelled in the holds.” To the perils of the sea against which she was insured under the Policy founded on there was a warranty of exception — the words of the warranty being “free…from all consequences of hostilities or warlike operations.” The question in the appeal is whether the loss of the vessel was proximately caused by such hostilities or warlike operations. If so, the insurers stand free; if not, the insured can recover under the policy against perils of the sea. I am of opinion that the loss was caused because the vessel was torpedoed, and that the warranted exception applies. …By the Marine Insurance Act, 1906 (6 Edw 7, c 41), s 55, the expression has become statutory and “the insurer is liable for any loss proximately caused by a peril insured against, but, subject as aforesaid, he is not liable for any loss which is not proximately caused by a peril insured against.” In this way the discussion of the scope of proxima causa is very relevant and its ascertainment vital. In my opinion, my Lords, too much is made of refinements upon this subject. The doctrine of cause has been, since the

time of Aristotle and the famous category of material, formal, efficient, and final causes, one involving the subtlest of distinctions. The doctrine applied in these to existences rather than to occurrences. But the idea of the cause of an occurrence or the production of an event or the bringing about of a result is an idea perfectly familiar to the mind and to the law, and it is in connection with that that the notion of proxima causa is introduced. Of this, my Lords, I will venture to remark that one must be careful not to lay the accent upon the word “proximate” in such a sense as to lose sight of or destroy altogether the idea of cause itself. The true and the overruling principle is to look at a contract as a whole and to ascertain what the parties to it really meant. What was it which brought about the loss, the event, the calamity, the accident? And this not in an artificial sense, but in that real sense which parties to a contract must have had in their minds when they spoke of cause at all. To treat proxima causa as the cause which is nearest in time is out of the question. Causes are spoken of as if they were as distinct from one another as beads in a row or links in a chain, but-if this metaphysical topic has to be referred to-it is not wholly so. The chain of causation is a handy expression, but the figure is inadequate. Causation is not a chain, but a net. At each point influences, forces, events, precedent and simultaneous, meet; and the radiation from each point extends infinitely. At the point where these various influences meet it is for the judgment as upon a matter of fact to declare which of the causes thus joined at the point of effect was the proximate and which was the remote cause. What does “proximate “here mean? To treat proximate cause as if it was the cause which is proximate in time is, as I have said, out of the question. The cause which is truly proximate is that which is proximate in efficiency. That efficiency may have been preserved although other causes

may meantime have sprung up which have yet not destroyed it, or truly impaired it, and it may culminate in a result of which it still remains the real efficient cause to which the event can be ascribed. I illustrate that by the present case. Did the vessel perish because she was torpedoed or by a peril of the sea apart from that? It is replied: “She perished by a peril of the sea because sea water entered the gash in her side which the torpedo made.” Certainly the entry of sea water was a peril of the sea, and certainly that entry of sea water was proximate in time to the sinking. But how could there be any exception in the case of a vessel lost in harbour or at sea to a loss by perils of the sea if the proximate cause in the sense of nearness in time to the result were the thing to be looked to? It is hardly possible for the mind to figure any thing which would interfere with or be an exception to a cause so proximate as the entry of sea water into or over the hull as the vessel sinks in the waves. The result of this is that the consideration of the exception of the consequences of hostilities, or indeed any other exception so far as I can at present figure, if that consideration be limited to a cause proximate in time, destroys the exception altogether. It might as well never have been written. In my opinion, accordingly, proximate cause is an expression referring to the efficiency as an operating factor upon the result. Where various factors or causes are concurrent, and one has to be selected, the matter is determined as one of fact, and the choice falls upon the one to which may be variously ascribed the qualities of reality, predominance, efficiency. Fortunately this much would appear to be in accordance with the principles of a plain business transaction, and it is not at all foreign to the law. In Reischer’s Case [see [1005]] Lord Lindley (then Lord Justice), speaking of causa proxima says, “this rule is based on the intention of the parties as expressed in the contract into which they have entered; but the rule must be applied

with good sense, so as to give effect to, and not to defeat, those intentions.” A second example, which I here give, shows that although insurers may limit their liability expressly to causa proxima and with elaborate astuteness may enumerate other facts and circumstances which would not be considered direct or proximate causes, the same result will follow, namely, that the proximate cause will be found to be, to use the words employed by Channell J in Etherington’s Case [see [1022]], “the real effective cause of what has happened.” “You must,” said he, “have something that may be called a new intervening cause, in order to prevent the existing cause which is operating to produce a well-known result from being said to be the real effective cause of what has happened.” Vaughan Williams LJ thought this view of Channell J was quite right. So do I. To apply this to the present case. In my opinion the real efficient cause of the sinking of this vessel was that she was torpedoed. Where an injury is received by a vessel, it may be fatal or, it may be cured: it has to be dealt with. In so dealing with it there may, it is true, be attendant circumstances which may aggravate or possibly precipitate the result, but which are incidents flowing from the injury, or receive from it an operative and disastrous power. The vessel, in short, is all the time in the grip of the casualty. The true efficient cause never loses its hold. The result is produced, a result attributable in common language to the casualty as a cause, and this result, proximate as well as continuous in its efficiency, properly meets, whether under contract or under the statute, the language of the expression “proximately” caused.’

Lord Dunedin: ‘…My Lords, we have had a large citation of authority in this case, and much discussion on what is the true meaning of cause proxima. Yet I think the case turns on a pure question of fact to be determined by common-sense principles. What

was the cause of the loss of the ship? I do not think the ordinary man would have any difficulty in answering she was lost because she was torpedoed…’

[1007] H Bennett, ‘Causation in the Law of Marine Insurance: Evolution and Codification of the Proximate Cause Doctrine’ in D Rhidian Thomas, ed, The Modern Law of Marine Insurance (London, LLP, 1996) ‘These decisions firmly establish three propositions regarding the modern law of proximate causation in marine insurance. First, the proximate cause is that which is effective, dominant or real. It is not simply that which is last in time. Secondly, the proximate cause doctrine represents the assumed intentions of the parties as reasonable business or seafaring people. Consequently, dominance or efficiency is determined according to business common sense rather than philosophy. Thirdly, and extremely importantly, contests between allegedly competing causes are not to be engineered by artifically splitting the elements of one complex cause.’

Notes: 1. Lord Sumner, who also sat in the House of Lords in Leyland Shipping, had remarked in an earlier case that, ‘Proximate cause is not a device to avoid the trouble of discovering the real cause or the “common-sense cause”’ (Becker, Gray and Co v London Assurance Corpn [1918] AC 101 (HL)). Later, Lord Greene MR declared that

causation ‘is really a matter for the common sense and intelligence of the ordinary man’ (Athel Line Ltd v Liverpool & London War Risks Insurance Association Ltd [1946] 1 KB 117 (CA)), and Lord Denning MR spoke of ‘the effective or dominant cause of the occurrence, or, as it is sometimes put, what is in substance the cause, even though it is more remote in point of time, such cause to be determined by common sense.’ (Gray v Barr, Prudential Assurance Co Ltd (Third Party) [1971] 2 QB 554 (CA)) In a case where the cause of the stranding of a ship was in dispute, Lord Wright said, ‘This choice of the real or efficient cause from out of the whole complex of the facts must be made by applying commonsense standards. Causation is to be understood as the man in the street, and not as either the scientist or the metaphysician, would understand it. Cause here means what a business or seafaring man would take to be the cause without too microscopic analysis but on a broad view.’ (Yorkshire Dale Steamship Co v Minister of War Transport [1942] AC 691 (HL), 706) 2. ‘The question is, was it reasonably certain at the time the event, which is alleged to have caused the loss, happened that it would lead to a loss of the type which occurred, even if the actual extent of the loss which occurred was greater than might reasonably have been expected?’ (J P Lowry and P J Rawlings, Insurance Law:

Doctrines and Principles (Oxford, Hart Publishing, 1999), p 147). 3. In Britain SS Co v The King [1921] 1 AC 99 (HL), the Matiana was sailing in convoy from England to Alexandria during the First World War. The convoy was under the orders of a British escort which ordered it to sail a more northerly route than usual to avoid enemy submarines. The Matiana ran aground. The loss was held to have been caused by a marine peril — running aground — rather then by war, which was excluded under the policy. This was because, although the escort had ordered the ship’s course and the authority to do this rested on Britain being at war, the escort had not ordered the ship to run aground.

10.2 The Proximate Cause Rule Overseas The proximate cause rule has been adopted in other common law jurisdictions. For instance, in Australia, Samuels JA referred to various English cases and took the view that the application of the rule involved a search for ‘the direct’, ‘real or commonsense’, ‘dominant’, ‘operative or efficient’ (National & General Insurance Co Ltd v Chick [1984] 2 NSWLR 86 (Court of Appeal, New South Wales), 97). In the US the proximate cause rule has also been accepted, but in construing its meaning the courts have veered between an approach resembling that used in Leyland Shipping and one involving a search for the

cause closest in time to the loss. Keeton and Widiss have suggested that, ‘Courts may…preserve an insured’s right to coverage by invoking the proximate cause concept to limit the effect of a coverage restriction or limitation.’ (RE Keeton and AI Widiss, Insurance Law: A Guide to Fundamental Principles, Legal Doctrines, and Commercial Practices (1988, West Publishing: St Paul, Minn.), p 554). [1008] California Insurance Code (2000) ‘530. An insurer is liable for a loss of which a peril insured against was the proximate cause, although a peril not contemplated by the contract may have been a remote cause of the loss; but he is not liable for a loss of which the peril insured against was only a remote cause. … 532. If a peril is specially excepted in a contract of insurance and there is a loss which would not have occurred but for such peril, such loss is thereby excepted even though the immediate cause of the loss was a peril which was not excepted.’

[1009] Bird v St Paul Fire & Marine Insurance Co 120 NE 86 (New York Court of Appeals, 1918) [Freight cars, which were about 1000 yards away from the insured ship, caught fire and then exploded. The concussive effect of this explosion damaged the ship. At no time did the ship catch fire. The court held

that the insurers of the ship were not liable under a fire policy]. Cardozo J: [having citied with approval the statement of Willes J quoted above at [1004] ‘our guide is the reasonable expectation and purpose of the ordinary businessman when making an ordinary business contract. It is his intention, expressed or fairly to be inferred, that counts. There are times when the law permits us to go far back in tracing events to causes… The case comes, therefore, to this. Fire must reach the thing insured, or come within such proximity to it that damage, direct or indirect, is within the compass of reasonable probability. Then only is it the proximate cause, because then only may we suppose that it was within the contemplation of the contract…’

[1010] Queen Insurance Co v Globe & Rutgers Fire Insurance Co 263 US 487 Holmes J: ‘The common understanding is that in construing these policies we are not to take broad views but generally are to stop our inquiries with the cause nearest to the loss. This is a settled rule of construction, and if it is understood, does not deserve much criticism, since theoretically at least the parties can shape their contract as they like.’

[1011] Pan American World Airways, Inc v Aetna Casualty & Surety Corp 505 F2d 989 (US Court of Appeals, 2d Cir, 1974) [In September 1970 two members of the Popular Front for the Liberation of Palestine (PFLP) hijacked a

Pan American Boeing 747, which was en route from Brussels to New York. The men forced the plane to fly to Beirut and then to Cairo where, after the evacuation of the passengers and crew, it was blown up. Pan Am claimed from their insurers under an allrisks policy which excluded loss caused by military or warlike operations. The court held the insurers liable]. Hays J: ‘New York courts give especially limited scope to the causation inquiry. The leading case is Bird v St. Paul & Marine Insurance Co [see [1009]]…These cases establish a mechanical test of proximate causation for insurance cases, a test that looks only to the “causes nearest to the loss.”… This rule is adumbrated by the maxim contra proferentem: if the insurer desires to have more remote causes determine the scope of exclusion, he may draft language to effectuate that desire…In the present case, events drawn from the general history of unrest in the Middle East did not proximately cause the destruction of the 747. Of course, in some attenuated “cause of causes” sense, the loss may have resulted from the Fedayeen or PFLP pattern of military operations against Israel, from the domestic unrest in Jordan, or from the most recent of the three wars which prior to 1970 had convulsed the Middle East. But for insurance purposes, the mechanical cause of the present loss was two men, who by force of arms, diverted Flight 093 from its intended destination.’

Notes: 1. In his judgment Justice Hays referred to the decision in Britain SS Co v The King [1921] 1 AC 99 (HL) (above) as supporting the proposition

put forward by Cardozo J and Holmes J, that proximate cause involved a search for the cause closest in time; he made no reference to Leyland Shipping. Cardozo J’s view might better be seen as no more than the simple assertion that insurers are only liable where the cause of the loss is an insured peril: that, for instance, a fire policy covers only loss by fire (see below, Part 10.5). 2. The decision in Bird v St Paul Fire & Marine Insurance Company (see [1009]) was also relied on in Continental Insurance Co v Arkwright Mutual Insurance Co 102 F 3d 30 (US Court of Appeals, 1st Cir, 1996). In the latter case the court accepted that under New York law the proximate cause rule was narrowly defined, but that this did not simply mean looking for the cause nearest in time to the loss. This approach was reconciled with the reasoning in Pan American by arguing that the court in that case had said ‘proximate causation is determined by a “mechanical…test that looks only to the causes nearest to the loss.”…Its use of the plural permits more than one cause to be considered.’ This led the court in Continental Insurance to conclude: ‘In sum, absent an explicit policy declaration of the parties’ intention, the contemplation of their insurance contract must be inferred by the court from all the circumstances surrounding the loss, including whether a peril insured against came directly or indirectly within such proximity to

the property insured that the damage it sustained fairly can be considered “within the compass of reasonable probability.” [citing Bird, see [1009]] Among the factors which must be assessed are the spatial and temporal proximity between the insured peril and the claimed loss.’

Most states have, however, taken a view of proximate cause that resembles Leyland Shipping. [1012] Graham v Public Employees Mutual Insurance Co 656 P2d 1077 (Supreme Court of Washington, 1983) [In 1980 Mount St Helens erupted and hot ash poured out melting the snow on the mountainsides. This combined with heavy rain from the eruption cloud, existing ground water, water from a lake and general debris from the explosion to create flows of mud that moved along the valley. Some ten hours after the eruption started, houses owned by the insured, which were 20–25 miles from the mountain, were destroyed by the mudflow or by the combined effect of flooding followed by mudflows. The relevant policy excluded loss by, among other things, earth movement or flood. By a majority the court expressly overruled an earlier decision that had defined proximate cause in terms of ‘direct, violent and efficient cause’]. Dore J: ‘Because direct loss from an explosion resulting from earth movement is not excluded from coverage, the jury must also determine the factual issue of whether the earth

movements were caused by the earthquakes and harmonic tremors which preceded the eruption. If the jury determines the volcanic eruption was an explosion resulting from earth movement, it will then be necessary to reach the issue of whether the loss was a direct result of the eruption… …we conclude the immediate physical cause analysis is no longer appropriate and should be discarded…We have defined “proximate cause” as that cause “which, in a natural and continuous sequence, unbroken by any new, independent cause, produces the event, and without which that event would not have occurred”…Where a peril specifically insured against sets other causes in motion which, in an unbroken sequence and connection between the act and final loss, produce the result for which recovery is sought, the insured peril is regarded as the “proximate cause” of the entire loss…It is the efficient or predominant cause which sets into motion the chain of events producing the loss which is regarded as the proximate cause, not necessarily the last act in a chain of events… …A jury could reasonably determine the water displacement, melting snow and ice and mudflows were mere manifestations of the eruption, finding that the eruption of Mt St Helens was the proximate cause of the damage to the appellants’ home.’

10.3 Multiple Causes Difficulties arise where there is more than one proximate cause of the loss and only one of these is an insured peril. In English law the liability of the insurers depends on whether the other cause is

simply not mentioned in the policy or is expressly excluded.

10.3.1 (i) Where the other cause is not mentioned in the policy [1013] JJ Lloyd Instruments Ltd v Northern Star Insurance Co Ltd (The ‘Miss Jay Jay’) [1987] 1 Lloyd’s Rep 32 (CA) [The Court of Appeal held that a ship, The Miss Jay Jay, had been lost as the result of the combination of two circumstances: the adverse condition of the sea, which was an insured peril, and defects in the boat’s design, which was not mentioned in the policy and of which the insured could not reasonably have been expected to be aware. The insurers were held liable]. Lawton LJ: ‘It now seems to be settled law, at least as far as this Court is concerned, that, if there are two concurrent and effective causes of a marine loss, and one comes within the terms of the policy and the other does not, the insurers must pay.’ Slade LJ: ‘As there were no relevant exclusions or warranties in this policy the fact that there may have been another proximate cause did not call for specified mention since proof of a peril which was within the policy was enough to entitle the plaintiffs to judgment.’

10.3.2 (ii) Where the other cause is an excluded peril [1014] Wayne Tank and Pump Co Ltd v Employers’ Liability Assurance Corpn Ltd [1974] QB 57 (CA) [Wayne were engineers employed to design and install equipment for the storage and conveyance of liquid wax in a factory. They used plastic pipe and a thermostat to regulate the temperature of the wax. After installation, but before being tested, the equipment was switched on and left unattended overnight. There was then a fire that destroyed the factory, which was held to be the result of two causes: (1) the use of plastic pipe, which was dangerous in such an application, and an ineffective thermostat; (2) the switching on by the engineers of the equipment and then leaving it unattended. Wayne had a public liability policy indemnifying them ‘against all sums which the insured shall become legally liable to pay as damages consequence upon… damage to property as a result of accidents’ which occurred in the course of their business on premises other than those of the insured. The loss was within these terms, but the insurers argued the policy excluded liability in respect of ‘damage caused by the nature or conditions of any goods or the containers thereof sold or supplied by or on behalf of the insured.’ The Court of Appeal concluded that the equipment installed was goods, and, reversing the

decision of Mocatta J at first instance, held that the insurers were not liable]. Lord Denning MR: [His lordship took the view that the dominant cause was the dangerous installation.] ‘That is enough to decide the case. But I will assume, for the sake of argument, that I am wrong about this, and that there was not one dominant cause, but two causes which were equal or nearly equal in their efficiency in bringing about the damage. One of them is within the general words and would render the insurers liable. The other is within the exception and would exempt them from liability. In such a case it would seem that the insurers can rely on the exception clause. There is not much authority on it, but it seems to be implied in John Cory & Sons v Burr (1883) 8 App Cas 393, especially from what Lord Blackburn said at pp 400, 401. That case was submitted, as used by Mr RA Wright KC arguing in Leyland Shipping Co v Norwich Union Fire Insurance Co [1918] AC 350, 353, for the proposition: “…where there are two perils both of which are proximate causes of the loss and in an open policy the shipowner could have recovered on either, then, if one of those perils is excepted by the warranty the underwriters are not liable.” Lord Shaw of Dunfermline, at p 371, expressed his indebtedness to that argument. In addition there is Board of Trade v Hain Steamship Co Ltd [1929] AC 534, where Viscount Sumner, at p 541, says that where there is one loss which is the product of two causes, joint and simultaneous and loss due to one of the causes is exempt being “warranted free” then the underwriters are not liable. The reason is that if the underwriters were held liable for loss, they would not be free of it. Seeing that they have stipulated for freedom, the only way of giving effect to it is

by exempting them altogether. The loss is not apportionable. Hence no part of it can fall on the policy. Lord Atkin, at p 544, agreed with that judgment. Mr Le Quesne sought to avoid the impact of that judgment by submitting that “warranted free” in a marine insurance policy had a different effect from an exception in a nonmarine policy. But it seems to me that it has no different effect. It is simply a different mode of expression. The result is that, although this accident comes within the general words at the opening of the policy, nevertheless seeing that there is a particular exception, the exception takes priority over the general words. General words always have to give way to particular provisions. In the present case one of the causes which was efficient to produce the damage was the nature of the goods supplied by the insured. The insurers are exempt from liability for it. Their exemption is not taken away by the fact that there was another cause equally efficient also operating to cause the loss. But I do not rest my opinion on this alternative ground. I rest it on the first ground that the dominant and effective cause of the loss was the nature of the goods supplied. It is within the exception. The defendants are not liable. I would allow the appeal accordingly.’

Cairns LJ: ‘…for my part I do not consider that the court should strain to find a dominant cause if, as here, there are two causes both of which can properly be described as effective causes of the loss. Mr Le Quesne recognised that if there are two causes which are approximately equal in effectiveness, then it is impossible to call one rather than the other the dominant cause. I should prefer to say that unless one cause is clearly more decisive than the other, it should be accepted that there are two causes of the loss and no attempt should be made to give one of them the quality of

dominance. On this approach if one cause is within the words of the policy and the other comes within an exception in the policy, it must be taken that the loss cannot be recovered under the policy. The effect of an exception is to save the insurer from liability for a loss which but for the exception would be covered. The effect of the cover is not to impose on the insurer liability for something which is within the exception. This was a view of the case which was suggested by Roskill LJ in the course of the argument, and I am satisfied that it is right in principle and that support can be found for it in the reported cases. I refer, without quoting the passages, to Cory’s case, 8 App Cas 393, per Earl of Selborne LC at p 397, and per Lord Blackburn at p 401; to P. Samuel & Co Ltd v Dumas [1924] AC 431, 467 and 468, per Lord Sumner; and to Atlantic Maritime Co Inc v Gibbon [1954] 1 QB 88, per Sir Raymond Evershed MR at pp 118, 119, and Morris LJ at p 138…’

Notes: 1. Although it was the view of Cairns LJ that the courts should not ‘strain to find a dominant cause’, the paucity of multiple cause cases suggests that the courts do look for a single cause: on this issue, City Centre Cold Store Pty Ltd v Preservatrice Skandia Insurance Ltd (1985) 3 NSWLR 739 (Supreme Court, New South Wales), 744–5 per Clarke J, and in Canada, see Milashenko v Co-operative Fire & Casualty Co (1968) 1 DLR (3d) 89 (affirmed by the Supreme Court of Canada at (1970) 11 DLR (3d) 128). One major problem with the Wayne Tank rule — as in so much of insurance law — is

that an insured is likely to be unaware of the impact of this rule and to assume that the exclusion of one cause will not prevent a claim where a covered peril has also been operating: see K Sutton, “Recent Developments in Insurance Law”, paper delivered to the New South Wales Insurance Law Association, Sep 2002 (www.aila.com.au/research). 2. Keeton and Widiss (Insurance Law: A Guide to Fundamental Principles, Legal Doctrines, and Commercial Practices, (St Paul, Minn, West Publishing, 1988), pp 557-9) argued that, in the USA: ‘when there are several distinct or distinguishable factors which contribute to a loss, a persuasive case can be made for the proposition that courts will apply the causation theory that will relate the loss to a covered peril…In many instances, decisions on causation questions involving insurance policy terms are best understood as manifestations of the judicial inclination to favor coverage either by construing ambiguous policy provisions against an insurer or by protecting the reasonable expectations of an insured.’

Keeton and Widiss’s excellent book tends to the conclusion that the US courts seek to construe policies and rules in ways that reflect the ‘reasonable expectations of an insured’. This has been an influential view, but it remains controversial (see chapter 9). 3. Some US states take the same approach as in England and deny recovery: Lydick v Insurance

Company of North America 187 NW 2d 602 (Supreme Court of Nebraska, 1971). Other states avoid the issue by insisting on the identification of a single cause, but this has not prevented cases arising where there are two independent and concurrent proximate causes. See LA Wans, ‘Washington’s Invalidation of Unambiguous Exclusion Clauses in Multiple Causation Insurance Cases’, (1992) 67 Wash L Rev 215. In the Supreme Court of California it has been said that ‘where there is a concurrence of different causes, the efficient cause — the one that sets others in motion — is the cause to which the loss is to be attributed, though the other causes may follow it, and operate more immediately in producing the disaster.’ (Sabella v Wisler 377 P.2d 889 (1963)) In another decision by the same court it was held that there is no liability where the covered peril is not ‘the efficient proximate cause of the loss (meaning predominating cause)’ or the excluded peril is the efficient proximate cause (Garvey v State Farm Fire and Casualty Co 770 P 2d 704 (1989), see [1015]). The difficulty for the California courts has been to reconcile sections 530 and 532 of the California Insurance Code (see [1008]). In Sabella it was decided that, although on its face section 532 precludes recovery because the loss would not have occurred ‘but for’ a peril that was excluded by the policy, this result was absurd. The court, therefore, held that the sections were not designed to exclude recovery if the cause that set the other causes in

motion was an insured peril, even if other, uninsured causes followed. It would, the court said, be otherwise if the insured peril was merely a remote cause or if the proximate cause — that is, the one that set the others in motion — was an excluded risk. Yet, this did not deal with the situation where there were two proximate causes. In State Farm Mutual Auto Ins Co v Partridge 514 P.2d 123 (California, 1973), the insured shot and injured his friend. The court found that there were two concurrent causes of the injury: the insured’s negligent action in filing down the trigger mechanism to create a ‘hair trigger’ on his gun and his negligence in driving with the gun in his hand while his friend sat in the passenger seat. A single efficient proximate cause could not be identified because both events were independent of each other and yet without both of them the injury could not have happened: the filing of the trigger did not cause the negligent driving and the negligent driving did not cause the filing of the trigger, and yet without the filed trigger and the negligent driving there would have been no shooting and no injury. The problem was that, if the shooting had been caused by the filing of the trigger, then the insurer would be liable on a homeowner’s policy, but that policy excluded injury caused by negligent driving. The court held the insurers liable by developing a rule that where there are two proximate causes and one is insured against, the insurers will be liable irrespective of the fact that the other cause is not insured. In Garvey v State Farm Fire and Casualty Co 770 P 2d 704 (1989, below [1015]) the same court noted a

distinction between third-party liability policies, such as that in Partridge (even though the liability insurance was in a policy that was mainly concerned with first-party insurance), and first-party property insurance. [1015] Garvey v State Farm Fire and Casualty Co 770 P 2d 704 (Supreme Court of California, 1989) Lucas CJ: ‘the right to coverage in the third-party liability insurance context draws on traditional tort concepts of fault, proximate cause and duty. This liability analysis differs substantially from the coverage analysis in the property insurance context, which draws on the relationship between perils that are either covered or excluded in the contract. In liability insurance, by insuring for personal liability, and agreeing to cover the insured for his own negligence, the insurer agrees to cover the insured for a broader spectrum of risks… In the property insurance context, the insurer and the insured can tailor the policy according to the selection of insured and excluded risks and, in the process, determine the corresponding premium to meet the economic needs of the insured. On the other hand, if the insurer is expected to cover claims that are outside the scope of the first-party property loss policy, an “all-risk” policy would become an “all-loss” policy…In most instances, the insured can point to some arguably contributing factor…if the rule in Partridge… were extended to first-party cases, the presence of such a cause, no matter how minor, would give rise to coverage… Finally…the reasonable expectations of the insurer and the insured in the first-party property loss portion of a

homeowner’s policy — as manifested in the distribution of risks, the proportionate premiums charged and the coverage for all risks except those specifically excluded — cannot reasonably include an expectation of coverage in property loss cases in which the efficient proximate cause of the loss is an activity expressly excluded under the policy.’

10.4 Collateral Loss What happens if the loss is caused not by the insured peril but by efforts to prevent, avert or minimise its effect? For instance, if a fire breaks out in the warehouse in which the insured goods are stored and, although the goods do not catch fire, they are damaged by water sprayed on them in an effort to prevent the spread of fire, is the loss covered by a fire policy? Similarly, where attempts are made to prevent or minimise loss by an insured peril that result in expenditure by the insured, are the costs recoverable if those efforts fail and the goods are lost? It is a key principle of contract law that parties must take reasonable measures to mitigate loss resulting from a breach of contract, but it is less clear whether this applies to the losses suffered by an insured since they do not result from a breach of contract by the insurer. The relative paucity of caselaw on these issues is doubtless because it is often not in the interests of insurers to dispute claims where to do so might discourage others from actions taken to avert or minimise loss.

When the crew of the Segundo closed the ventilators, they were seeking to prevent the inflow of seawater during rough weather and, although the lack of ventilation damaged the cargo, the Privy Council held that this loss was caused by rough weather, which was an insured peril: as Lord Wright put it, ‘such a mere matter of routine seamanship necessitated by the peril that the damage can be regarded as the direct result of the peril’ (Canada Rice Mills Ltd v Union Marine and General Insurance Co [1941] AC 55 (PC), 70). Where bombing reduced a building’s security and enabled thieves to steal goods, the loss was caused by theft and not the war: Winicofsky v Army and Navy General Assurance Association Ltd (1919) 88 LJKB 1111 (but see the Canadian decision, Thompson v Montreal Insurance Co (1850) 6 UCQB 319), while in Marsden v City and County Insurance Co (1865) LR 1 CP 232, fire insurers were not liable for property damage caused by a mob that had been drawn to the vicinity by a fire in a neighbouring building. However, where the insured peril is operating (for instance, the fire has broken out in the warehouse) and the insured removes the goods to the street from where they are stolen, it seems reasonable to suppose that this is a loss by fire. The insured peril must be operating and must be acting upon the insured subject matter (Everett v London Assurance (1865) 19 CBNS 126): insurers were not liable on a fire policy where a master of a vessel, who was acting under the reasonable but erroneous belief that steam was smoke, had operated the fire-fighting equipment and so damaged the

cargo (Joseph Wilson & Son Ltd v Firemen’s Fund Insurance Co of San Francisco [1922] 2 KB 355). The difficulty is to distinguish when a peril is operating from when it is merely apprehended: ‘Is it a fear of something that will happen in the future or has the peril already happened and is it so imminent that it is immediately necessary to avert the danger by action?’ (Symington & Co v Union Insurance Society of Canton Ltd (1928) 139 LT 386 (CA), 390 per Scrutton LJ). The distinction to be drawn is between action taken to avert the consequences of a peril that was affecting the subject matter, for which the insurers will be liable, and action to prevent the subject matter being affected by a peril, for which the insurers will not be liable. In Becker, Gray & Co v London Assurance Co [1918] AC 101 (HL), the outbreak of the First World War led the master of a German vessel to put into a neutral harbour to avoid capture and this meant the loss of the voyage. The insurers were not held to be liable on the policy because the loss was proximately caused by the voluntary act of the master in suspending the voyage. On the other hand, in The Knight of St Michael [1898] P 30, a cargo of coal became overheated leading the master to unload the vessel. The insurers were liable on a fire policy, even though fire had not broken out, because a fire would have started if no action had been taken. Professor Bennett’s view is that the loss came within the terms of the policy, either as a loss by fire or ejusdem generis thereto (see [913]). He goes on to remark:

‘The latter analysis has subsequently been preferred [Tempus Shipping Co Ltd v Louis Dreyfus & Co Ltd [1930] 1 KB 699, 700], in which case, given the absence of the eiusdem generis clause from the modern Institute clauses, the assured would not today recover under the peril of fire. The Institute Coal Clauses, however, cover loss or damage “reasonably attributable to…fire explosion or heating, even when caused by spontaneous combustion, inherent vice or nature of the subject matter insured.’ (H Bennett, ‘Causation in the Law of Marine Insurance: Evolution and Codification of the Proximate Cause Doctrine’ in D Rhidian Thomas, ed, The Modern Law of Marine Insurance (1996, LLP: London).

[1016] N Legh-Jones, J Birds and D Owen, eds, Macgillivray on Insurance Law, London, Sweet & Maxwell, 2003 [footnotes omitted] ‘26-18 (1) It is doubtful whether a court would imply any general term that an insured should take reasonable steps to avert or minimise a loss. This is partly because it is easy to make express provision for such an obligation and business efficacy will not usually require the implication of a term which is commonly incorporated as an express term. Another reason is that the doctrine of proximate causation can often do the work of such an implied term. If the insured suffers loss because he has decided not to take a step which it would be reasonable for him to have taken, his loss will be held to have been proximately caused by that decision rather than the operation of any peril insured against.

26-19 (2) The cost of taking measures to avert or minimise a loss will not often be recoverable from insurers. If no provision for such costs are included in the policy, any recoverability will have to be implied and it may be difficult to formulate an implied term with any great precision…’ [1017] Marine Insurance Act 1906 ‘Section 78(1) Where the policy contains a suing and labouring clause, the engagement thereby entered into is deemed to be supplementary to the contract of insurance, and the assured may recover from the insurer any expenses properly incurred pursuant to the clause, notwithstanding that the insurer may have paid for a total loss, or that the subject-matter may have been warranted free from particular average, either wholly or under a certain percentage. … (3) Expenses incurred for the purpose of averting or diminishing any loss not covered by the policy are not recoverable under the suing and labouring clause. (4) It is the duty of the assured and his agents, in all cases, to take such measures as may be reasonable for the purpose of averting or minimising a loss. [1018] Aitchison v Loire (1879) 4 App Cas 755 (HL)

Lord Blackburn: ‘the object [of a sue and labouring clause]…is to encourage and induce the assured to exert themselves, and therefore the insurers bind themselves to pay in proportion any expense incurred, whenever such expense is reasonably incurred for the preservation of the thing from loss, in consequence of the efforts of the assured or their agents.’

Modern marine policies generally incorporate the policy terms produced by the Institute of London Underwriters known as the Institute Clauses which contain specific sue and labour provisions. See S Hodges, Law of Marine Insurance (London, Cavendish, 1996), pp 453–69. [1019] Institute Cargo Clauses (A) ‘Duty of Assured Clause 16 It is the duty of the Assured and their servants and agents in respect of loss recoverable hereunder 16.1 to take such measures as may be reasonable for the purpose of averting or minimising such loss, and 16.2 to ensure that all rights against carriers, bailees or other third parties are properly preserved and exercised and the Underwriters will, in addition to any loss recoverable hereunder, reimburse the Assured for any charges properly and reasonably incurred in pursuance of these duties.’

[1020] Yorkshire Water Services Ltd v Sun Alliance & London Insurance Plc [1997] 2 Lloyd’s Rep 21 (CA)

[As the result of the failure of an embankment owned by YWS, sewage from its sewage works was deposited in the river Colne. One of the neighbouring property owners claimed against YWS for damage to its business and property that resulted from the flooding, and similar claims were expected from other property owners. To reduce the likelihood of such claims, YWS undertook flood alleviation works at a cost of over £4m. YWS sought to recover this expenditure under a public liability policy issued by Sun Alliance, which provided cover ‘against legal liability for damages’ in respect of accidental loss of or damage to material property and ‘all other costs and expenses in relation to any matter which may form the subject of a claim’. YWS also sought recovery under a policy issued by Prudential, which indemnified ‘the insured against all sums which the insured shall become legally liable to pay as damages or compensation in respect of…loss of or damage to property…happening in connection with the Business’]. Stuart-Smith LJ: ‘…Mr Griffiths [counsel for YWS] relied first on two English decisions, The Knight of St Michael [1898] P 30 which was approved by the Court of Appeal in Symington & Co v Union Insurance Society of Canton Ltd (1928) 97 LJKB 646 at p 650. These are cases of property insurance under marine insurance policies. In The Knight of St Michael the interest insured included inter alia the freight to be earned on delivery of a cargo of coal. The coal overheated and there was imminent risk of fire, so that much of it had to be unloaded and the freight lost. The perils insured against

were “fire and all other perils loss and misfortunes”. Mr Justice Barnes held that in the light of the imminent danger of fire it was a loss ejusdem generis and covered by the words “all other losses and misfortunes”. The case is of no assistance in considering a public liability policy. In Symington’s case a cargo of cork was awaiting loading when fire broke out on the jetty and in order to prevent the fire spreading, the port authority jettisoned a quantity of the cork and sprayed the remainder with sea water. The policy covered — “…loss or damage to the interest insured which may reasonably be attributed to fire.” It was held that the fire was an imminent peril and the proximate cause of the damage to the cork and thus the claim fell within the policy wording. Both cases are concerned with loss or damage to the property or interest insured and are not concerned with expense incurred by the insured to preserve the property. Even if such expenses were recoverable under such a policy, there is an important distinction between property and liability insurance. Recovery under the former is limited to the value of the property insured; any expense incurred in its preservation is therefore subject to the same limit. But in the case of expenses incurred by the insured to prevent liability to third parties for damage or further damage it is impossible to quantify such damage, since ex hypothesi it has not occurred. Accordingly the expense of the alleviation works may greatly exceed any possible or likely damage to third parties and the limit of indemnity is wholly inappropriate in such circumstances. In my judgment these cases do not assist the plaintiff and they turn, as one would expect, on the words used in the policy and do not lay down any doctrine…Mr Griffiths also sought to rely on a number of American authorities to support his contention. The earliest of these is Desrochers v New York Casualty Co (1954) 99 NH 129; 106A 2d 196, a

decision of the Supreme Court of New Hampshire. The language of the public liability policy was that the — “…insurer agreed to pay all sums which insured should become legally obligated to pay as damages because of injury to property.” It is very similar to that in the Sun Alliance and Prudential policies. The insured failed to recover the costs and expenses of complying with an injunction to restrain damage to third parties. It is therefore against the plaintiff’s contention in this case. Mr Griffiths cited a number of cases where the decision has gone in favour of the insured. Leebov v United States Fidelity & Guaranty Co, 165 Atlantic Reporter 2d series 82 (1960) Supreme Court of Pennsylvania. The Court distinguished the language of the policy from that of Desrochers; but there is no satisfactory analysis of the actual wording: the case seems to turn on the proposition that: “…it is folly to argue that if a policy owner does nothing and thereby permits the piling up of mountainous claims at the eventual expense of the insurance contract, he will be held blameless of all liability, but if he makes a reasonable expenditure and prevents a catastrophe he must do so at his own expense.” …[His lordship referred to several other US authorities.] These cases were for the most part carefully analysed by the learned Judge and I do not propose to do so again. Like him I do not derive much assistance from them. In some cases it is difficult to see how the Desrochers case is distinguishable; but what is clear is that the American Courts adopt a much more benign attitude towards the insured; this seems to be based variously on the “folly” argument in Leebov or “general principles of law and

equity”…or that insurance contracts are: “contracts of adhesion between parties who are not equally situated” giving rise to the principle: “…that doubts as to the existence or extent of coverage must generally be resolved in favour of insured…” or because the Courts have — “…adopted the principle of giving effect to the objectively reasonable expectations of the insured for the purpose of rendering a “fair interpretation” of the boundaries of insurance cover. [Broadwell Realty Services Inc v Fidelity and Casualty Co of New York, 528 Atlantic Reporter 2d series 76 (Superior Court of New Jersey)]”

For the most part these notions which reflect a substantial element of public policy are not part of the principles of construction of contracts under English law… In my judgment the fallacy of Mr Griffiths’ argument is that it seeks to elevate the “event” or “occurrence” into the peril insured against, whereas the peril insured against is in fact: “…legal liability for damages in respect of accidental loss or damage to material property [Sun Alliance] …all sums which insured shall become legally liable to pay as damages and compensation in respect of…loss or damage to property [Prudential].” It involves reading in between the words “against” and “legal liability” (Sun Alliance) some such words as “against all such costs and expenses incurred in respect of an event which may give rise to legal liability”. Such a major rewriting of the bargain is not in my view justified. In my judgment Mr Crowther’s analysis is correct when he submits that there are four steps leading to a claim under the Prudential policy. 1. the original cause; 2. an occurrence arising from the original cause, which is relevant to the limits of liability; 3. claims made by third parties in respect

of damage to property; 4. the establishment of legal liability to pay damages or compensation in respect of such sums. Or to put it another way there are four relevant requirements before an indemnity can be obtained under the policy. 1. Sums 2. which the insured shall become legally liable to pay 3. as damages or compensation 4. in respect of loss or damage to property. In this context “sums” must mean sums paid or payable to third party claimants. No such sum arises in relation to the flood alleviation works. “Legally liable to pay” must obviously involve payment to a third party claimant and not expenses incurred by the insured in carrying out works on his land or paying contractors to do so and the liability must be to pay damages or compensation. “Damages” means “sums which fall to be paid by reason of some breach of duty or obligation.” See Hall Brothers Steamship Co Ltd v Young (1939) 63 Ll Rep 143 at p 145. “Loss or damage to property” is a reference to the property of the third party claimant and not that of the insured. Mr Crowther relied on the cases of Post Office v Norwich Union Fire Insurance Society [1967] 2 QB 363 and Bradley v Eagle Star Insurance Co Ltd [1989] 1 AC 957 in which the Post Office case was affirmed. Both cases were concerned with claims where the plaintiff was suing the tortfeasor’s insurer direct under the Third Parties (Rights against Insurers) Act, 1930 and involved the question of what had to be established before the insured tortfeasor had a right to sue the insurer. Lord Denning, MR in the Post Office case said… “…so far as the ‘liability’ of the insured person is concerned, there is no doubt that his liability to the injured person arises at the time of the accident, when negligence and damage coincide. But the ‘rights’ of the insured person against the insurers do not arise at that time. The policy says that ‘the company will indemnify the insured against all

sums which the insured shall become legally liable to pay as compensation in respect of loss of or damage to property’. It seems to me that the insured only acquires a right to sue for the money when his liability to the injured person has been established so as to give rise to a right of indemnity. His liability to the injured person must be ascertained and determined to exist, either by judgment of the court or by an award in arbitration or by agreement. Until that is done, the right to an indemnity does not arise. I agree with the statement by Devlin J in West Wake Price & Co v Ching — “…the assured cannot recover anything under the main indemnity clause or make claim against the underwriters until they have been found liable and so sustained a loss…”

This passage was expressly approved in the House of Lords in Bradley’s case. It is subject to the gloss that the insured is entitled to sue for a declaration that the insurer will be liable to indemnify him, if this is disputed, before payment is actually made and the contract can be specifically enforced so that the insurer can be obliged to pay, (unless there is a “Pay to be paid” clause) without the insured actually having to pay first; but the liability to pay a quantified sum must be established. See per Lord Goff of Chieveley Firma C-Trade Ltd v Newcastle Protection and Indemnity Association Ltd [1990] 2 Lloyd’s Rep 191 at p 202… Mr Crowther also submitted that there is no logical distinction between preventative steps taken by the insured to avoid liability to third parties in the first place, the expense of which obviously, as Mr Griffiths accepted, cannot be recovered under such a policy, or preventative steps to avoid further damage to a third party who has already suffered some damage, but may in the absence of preventive measures suffer more, or to other different third parties who have not yet suffered any damage. Mr Griffiths submitted that it made all the difference that a third party had already suffered some damage. But I am unable to

follow the reasoning that is supposed to lead to this conclusion. [Stuart Smith LJ then referred to express terms of the policy, which were construed as requiring the insured to bear the cost of preventive measures undertaken before and after an event or occurrence. This disposed of the argument that a term should be implied into the policy entitling the insured to be indemnified for expenses reasonably incurred in undertaking preventive measures. However, Stuart-Smith LJ did go on to consider this issue as if there were no express terms.] Mr Griffiths’ argument proceeds like this: 1. The law requires an insured (in the absence of express terms) to make reasonable efforts to prevent or minimise loss which may fall to the insurers. This was originally pleaded as part of the implied term; but on second thoughts Mr Griffiths excised it and relied upon what he submitted as a general proposition of law, though he cited no authority in support of it. Since this is usually the subject of an express term imposing such a duty on the insured (and on the present hypothesis there is such an express term relating to pre- event precautions), I am not persuaded that there is such a general duty. It is not akin to the duty of the victim of a tort or breach of contract to mitigate the damage which the tortfeasor or contract breaker will otherwise have to pay for. 2. It is necessary to imply a term that the insurer will pay for these precautions to avoid the absurd consequences of requiring an insured to allow an insured peril to cause damage to the property of a third party, before an indemnity can be claimed from the insurer. But although it may be reasonable to imply such a term, and the American Courts seem in some cases willing to go down

this path, it does not seem to me to be necessary to do so to give business efficacy to the contract, nor is it one to which the officious bystander, if asked, would respond “of course”. This is particularly so when there is no logical difference between preventing damage in the first place (pre-event) and preventing further damage (post event). The first is expressly at the expense of the insured. I do not follow why the second should be impliedly at the expense of the insurers. 3. Mr Griffiths also relied upon the case of Netherlands Insurance Co Est 1845 Ltd v Karl Ljungberg and Co [1986] 2 Lloyd’s Rep 19. The insurers had given cover to the respondents who were consignees of goods which arrived lost or damaged. The consignees commenced proceedings in Japan against the carriers to preserve the claim before it was time barred and in Singapore against the insurers and obtained judgment against the latter. They claimed the cost of the Japanese proceedings against the insurers. There were two relevant provisions in the policy. The first, a sue and labour clause provided: “…and in the case of any Loss or Misfortune, it shall be lawful to the Assured, their Factors, Servants and Assigns, to sue, labour and travel for, in and about the Defence, Safeguard and Recovery of the said Goods and Merchandises or any Part thereof without Prejudice to this Assurance and to be reimbursed the Charges whereof by the Assurers…” and the second, the “bailee clause” provided: “It is the duty of the Assured and their agents, in all cases, to take such measures as may be reasonable for the purpose of averting or minimising a loss and to ensure that

all rights against carriers, bailees or other third parties are properly preserved and exercised.” It was conceded that the insurers were under an obligation to reimburse the insured’s expenses under the first part of the bailee clause. The question was whether there should be an implied term that they should also reimburse them in respect of expenses incurred in performing their duty under the second part. After referring to the sue and labour clause Lord Goff of Chieveley said at p 22, col 2; “…It can of course be said, as indeed it was said on behalf of the appellants, that the fact that the sue and labour clause makes express provision for reimbursement of the assured by the insurers, whereas the bailee clause does not do so, militates against the implication of a term in the bailee clause to the same effect. But it is not to be forgotten that a marine insurance policy consists of a number of provisions, some of which (often the most important) are provisions contained in one or more documents which are incorporated by reference; and their Lordships doubt if the terms of the sue and labour clause in the standard form have much impact on the construction of the bailee clause included in the Institute Cargo Clauses. They consider it to be of more significance that the bailee clause itself commences by imposing an obligation on the assured ‘to take such means as may be reasonable for the purpose of averting or minimising a loss’ without expressly stating whether costs so incurred by the assured shall be reimbursed by the insurers; and yet it was accepted in the course of argument that the assurers must be under a duty to make such reimbursement. The conjunction of the two obligations in the bailee clause, one of which admittedly carries a duty of reimbursement applies to both obligations under the clause.

The respondent placed in the forefront of their submissions the proposition that the obligation on the assured under the bailee clause properly to preserve and exercise all rights against carriers was an obligation imposed on them for the benefit of the insurers. Their Lordships do not feel able to accept that, as a general proposition, the mere fact that an obligation is imposed on one party to a contract for the benefit of the other carries with it an implied term that the latter shall reimburse the former for his costs incurred in performance of the obligation. But the fact that, in the present case, the relevant obligation is indeed for the benefit of the insurers is, their Lordships consider, a material factor which may be taken into account; and when that factor is considered together with all the other factors which their Lordships have set out, they consider that a term must be implied in the contract, in order to give business efficacy to it, that expenses incurred by an assured in performing his obligations under the second limb of the bailee clause (in the form now under consideration) shall be recoverable by him from the insurers in so far as they relate to the preservation or exercise of rights in respect of loss or damage for which the insurers are liable under the policy.” I do not think much if any assistance can be derived from this case in the plaintiff’s favour. It is clear that the mere fact that an obligation is imposed on one party for the benefit of another is not sufficient for the implication of a term that the latter will reimburse the expenses of performing it. Once the concession was made that insurers were liable to reimburse expenses incurred in respect of the first part of the bailee clause, it seems to me to follow that it would also apply to the second. In so far as there is an analogy to be drawn from that case the fact that pre-event precautionary steps are at the expense of the insured, suggests that post-event works would also be.

4. Mr Griffiths submitted that the reason why the plaintiff carried out the flood alleviation works was to prevent the insurers incurring substantial further liability if damage occurred to third parties. It is true that it may have had this consequence; but the plaintiffs were under a duty in tort not to cause injury to their neighbours and furthermore it was in their own interest to do so having regard to the £250,000 contribution and the limit of indemnity, which might be exceeded, perhaps not in this case, but in others. Mr Crowther drew our attention to section 74 of the Marine Insurance Act, 1906 which provides: “Where the assured has affected an insurance in express terms against any liability to a third party, the measure of indemnity, subject to any express provision in the policy, is the amount paid or payable by him to such third party in respect of such liability.” So far as liability to third parties is concerned the principles of marine insurance are not significantly different from nonmarine. In the light of this section it would I think be very difficult to contend that in marine liability policies there is an implied term such as the plaintiff contends for in this case. That being so, I see no reason why it should be implied in a non-marine policy. Finally I consider that the proposed term would be virtually unworkable. I do not see how, short of expensive litigation, it would be possible to decide what expenditure of the insured was reasonable. It is not just a question of considering whether the cost of the works themselves are reasonably priced, they must be proportional to the cost of the damage prevented. To take this case, if the only potential liability was the £300,000 paid to ICI, could it be said that £4m worth of alleviation works was reasonable? One would think not. Yet how is the cost of damage which has not occurred to be quantified? I do not know; and Mr

Griffiths’ submissions have not grappled with the point. There are also insoluble problems in apportioning liability for the expenditure between the insured and the first and second layer insurers.’

Notes: 1. In Yorkshire Water, Otton LJ commented: ‘with regard to the passage cited from MacGillivray & Parkington [see [1016]] it is only necessary to point out, first, that the example given to support the author’s suggestion concerns a property insurance and not a public liability policy. Secondly, the last sentence suggests an express sue and labour clause and not an implied one.’ With regard to this second point, he considered the situation where there was an express term requiring the insured to take reasonable measures to avert or minimise loss that did not specify which party was to bear the cost, such as a sue and labour clause in a marine policy. In such a case, where the measures clearly benefited the insurers, then there might be a good argument for implying a requirement that they pay not just for those measures, but also for the expenses incurred by the insured in taking the steps necessary for preserving the preserving rights in respect of the loss for which the insurers are liable under the policy (see Netherlands Insurance Co Est 1845 Ltd v Karl Ljungberg and Co [1986] 2 Lloyd’s Rep 19 (PC)). However, since Otton LJ,

like his fellow judges, took the view that the clause in Yorkshire Water expressly provided that the insured was to pay, he left this issue unresolved. See, C. Mitchell, “Restitutionary Recovery of Prevention Costs by an Insured” [1999] LMCLQ 30. 2. Under the California Insurance Code (2000): ‘531. Rescue from peril insured against An insurer is liable: (a) Where the thing insured is rescued from a peril insured against, and which would otherwise have caused a loss, if, in the course of such rescue, the thing is exposed to a peril not insured against, and which permanently deprives the insured of its possession, in whole or in part. (b) If a loss is caused by efforts to rescue the thing insured from a peril insured against.’ 3. In Guardian Assurance Co Ltd v Underwood Constructions Pty Ltd (1974) 48 ALJR 307 (High Court of Australia), 309, Mason J said: ‘It may be that costs reasonably incurred by an insured person pursuant to a contractual obligation or in the fulfilment of a duty to prevent or minimise liability to a third party should be regarded as falling within an indemnity against liability to others.’ 4. Expenses incurred in the rescue of the insured property were allowed by the Court of Appeal, Queensland, in Re Mining Technologies Australia Pty Ltd [1999] 1 Qd R 60. McPherson JA summed up the court’s view: ‘expenses incurred in averting or warding off the

imminent happening of an insured risk or peril are capable of being considered within the indemnity of the cover afforded against the loss itself.’ However, the judges differed in their reasoning. Davies JA thought there was an implied term to this effect in the policy, while McPherson JA believed the expenses came within the express terms of the policy. Davies JA added, obiter, that such expenses might not be recoverable if the rescue attempt failed. McPherson JA expressed no clear view on this issue.

10.5 Altering the Proximate Cause Rule The proximate cause rule is only presumptive and it is commonplace for insurers to attempt to restrict their liability by altering the rule through an express term in the policy: indeed, section 55(1), Marine Insurance Act 1906 (see [1003]) explicitly acknowledges this possibility. In the nineteenth century there was a proliferation of companies offering accident policies, spurred to some extent by the rapid expansion of the railways. These companies sought to reduce their liability by inserting terms that were intended to allow a search for the cause of an injury which went beyond the proximate cause rule. These terms prompted a good deal of case law in which their effect was challenged, and those cases, in turn, led the companies to rewrite their policies. The

decision in Isitt (see [1021]) led to a rewriting of accident polices, but the judges seem not to have taken kindly to this rewriting, as is shown by the comments of Vaughan Williams LJ in Etherington (see [1022]), where a rephrased clause failed to overturn the effect of Isitt. Scrutton J in Coxe (see [1023]) also showed some dislike of such a clause, but because it was clearly expressed he felt obliged to enforce it. [1021] Isitt v Railway Passengers Assurance Co (1889) 22 QBD 504 [Under a policy taken out by Isitt, the insurers were only liable ‘if the assured shall sustain any injury caused by accident,…and shall die from the effects of such injury.’ Isitt fell and dislocated his shoulder. He was put to bed and died within a month from pneumonia caused by cold. It was found that he would not have died in the way or at the time he did if it had not been for the accident. The injury had caused him such pain that he was restless, unable to wear his clothing and unusually susceptible to cold. The insurers were held liable]. Wills J: ‘Was, then, the death of the assured under the circumstances stated the natural consequence of the injury? I think it was. I think it idle to suggest that there is anything in these circumstances which tends to shew that the cold which led to the fatal attack of pneumonia was caught by the assured in some manner independent of the injury…Had the issue been submitted to a jury, I think that the proper direction would have been: “Do you think that the

circumstances leading up to the death, including the cold which caused pneumonia, were the reasonable and natural consequences of the injury and of the conditions under which the assured had to live in consequence of the injury? If you find that no foreign cause intervened and that nothing happened except what was reasonably to be expected under the circumstances, you may and ought to find that the death resulted ‘from the effects of the injury’ within the meaning of the policy.” ’

[1022] In the Matter of an Arbitration between Etherington and the Lancashire and Yorskhire Accident Insurance Co [1908] 1 KB 591 (CA) [Ambrose Etherington took out an accident policy which included the following term: ‘this policy only insures against death where accident within the meaning of the policy is the direct or proximate cause thereof, but not where the direct or proximate cause thereof is disease or other intervening cause, even although the disease or other intervening cause may itself have been aggravated by such accident, or have been due to weakness or exhaustion consequent thereon, or the death accelerated thereby.’ While out hunting, Etherington fell and, the ground being wet, he was soaked. The shock of the fall, the soaking and having to ride home in this state lowered his resistance and caused the development of pneumonia from which he died. The insurers were held liable by Channell J and that decision was confirmed on appeal].

Vaughan Williams LJ: ‘It was said that, the insurance companies not liking that decision [referring to Isitt], the proviso in the policy before us was framed for the very purpose of avoiding its effect in future. That may be historically true, but, if so, I think that, though that may have been the desire of the company, they have not had what I may call the commercial courage to express as plainly as they might have done what their counsel says they intended to express, namely, that the principle laid down in Isitt v Railway Passengers’ Assurance Co should not apply to their policies. There is another thing which I wish to say before proceeding to construe the policy. We have to construe this policy not merely in reference to this particular case; we must recollect that it is a document in the form which is used for the regular issue of policies by the company to persons who are desirous of insuring with them, and one must consider whither the construction contended for by the company would lead, if we were to adopt it. As far as I can see, if we adopted it, the result would be that it would be very difficult to establish the liability of the insurance company in any case except where the accident resulted in what may be called death on the spot. There is always in every other case a possibility of some supervening cause, and it would be very difficult for any one to look forward with any certainty to a sum being receivable on the policy if we were to put such a construction as was suggested upon a policy in this form. I think that some limitation of the terms of the proviso contained in the policy ought to be welcomed by the insurance companies themselves, for otherwise, in my opinion, the number of cases in which the policy could be enforced against the company would be so very much reduced that the practical result would soon be that very few persons would care to insure. Having said so much, I will read the first words used by Channell J in giving judgment: “Now the first question one

has to consider is what is meant by the term ‘intervening cause,’ when used in connection with the well-known doctrine about the causa proxima, in order that you may say in law that the effect is caused by another thing, and not directly caused by the accident. I think that the expression ‘new cause intervening’ is practically the same as that used here, ‘other intervening cause,’ and that it means some new and independent thing started, which together with the existing cause in some way or other — the one cause, possibly, in greater degree than the other cause, but the two acting together — ultimately causes a certain result; you must have something that may be called a new intervening cause, in order to prevent the existing cause which is operating to produce a well-known result from being said to be the real effective cause of what has happened.” In my opinion the view so expressed by Channell J is quite right. If that be so, then, upon the facts stated in the special case, I think the representative of the assured is entitled to judgment. The counsel for the company contended that, instead of saying that the new thing or new cause intended by the words “disease or other intervening cause” in the proviso must be something new and independent of the accident, we ought to read the words as meaning a new intervening cause, whether dependent on or independent of the accident. I do not agree. When the disease or other cause is dependent on the accident, I think it is right to say that the term “direct or proximate cause” covers in such a case not only the immediate result of the accident, but also all those things which may fairly be considered as results usually attendant upon the particular accident in question. In this case the assured fell from his horse. It was a heavy fall, and, though no breakage of bones, or wound, or obvious internal injury was caused, the fall involved a great shock to the system accompanied by a wetting. The assured had to ride home without a change of clothes, and the case makes it clear

that the first result of such an accident would be a lowering to a great extent of the vitality of the person exposed to such a shock and wetting. It is also clear that such a lowering of vitality is in the ordinary course of things likely to produce a great development of the pernicious activity of those germs called pneumococcic, which are stated to exist even in healthy persons, and that this increased activity of the germs would, unless the vitality were restored again, ultimately produce pneumonia; and it was of pneumonia so produced that the assured died…In my opinion, it is impossible to limit that which may be regarded as the proximate cause to one part of the accident. The truth is that the accident itself is ordinarily followed by certain results according to its nature, and, if the final step in the consequences so produced is death, it seems to me that the whole previous train of events must be regarded as the proximate cause of the death which results.’

[1023] Coxe v Employers’ Liability Assurance Corporation Ltd [1916] 2 KB 629 [As part of his military duties the insured, Captain Ewing, inspected sentries on a railway line, which, because of air raids, was poorly lit and to which access was forbidden to civilians. While undertaking these duties, he was killed by a train. Insurers were held not liable on a personal accident policy which excluded liability for death or injury ‘indirectly caused by, arising from, or traceable to…war.’] Scrutton J: ‘I start with the consideration that to all policies of insurance, whether marine or accident, the maxim causa proxima non remota spectatur is to be applied if possible.

The immediate cause must be looked at, and not one or more of the variety of causes which if traced without limit might be said to go back to the birth of the assured. For that reason, when there are words which at first sight go a little further they are still construed in accordance with that universal maxim…[I]f the defendants choose to employ very vague words…the words must be read strictly against them and in accordance with the ordinary maxim. But the words which l find it impossible to escape from are “directly or indirectly.” There does not appear to be any authority in which those words have been considered, and I find it impossible to reconcile them with the maxim causa proxima non remota spectatur…But a line must be drawn somewhere…If war had merely placed Captain Ewing in a position not specially exposed to any danger, and in that position a particular incident not connected with war caused his death, I think that most probably in that case the matter would not come within the condition. For instance, suppose that, in connection the war, the assured had gone to a military camp not in any way specially exposed to lightning, but where lightning had struck and killed him, I should be disposed to think that the war was so remote from the death that in that case it could not be said that the death was indirectly caused by the war, If, however, the war had placed the assured in a position specially exposed to danger, as for instance in a place where he was specially exposed to being struck by lightning — if such a place can be conceived — and he was there struck and killed by lightning, it appears to me to be a question of fact, not of construction, whether the death was indirectly caused by war. In the present case the arbitrator has found, as a fact, that the assured’s death was indirectly traceable to war; and it is clear upon the facts that he was placed in a position of special danger — namely, he had to be about the railway line performing his military duties at night with the lights

turned down, in consequence of war, and while doing his military duties in that position of special danger he was killed by reason of the special danger which prevails at that particular place and to which he was exposed by reason of his military duties.’

Note: As will be seen in the discussion of claims (chapter 11), other terms seek to restrict the ability of the insured to claim for a loss that has been proximately caused by an insured peril: theft policies often include a requirement that the insured take reasonable care of the goods.

11 Claims 11.1 Good Faith As commented in chapter 4, there has been considerable uncertainty surrounding the consequences of non-disclosure during the claims process. While in Black King Shipping Corp v Massie (The Litsion Pride) [1985] 2 Lloyd’s Rep 437, it was held that a fraudulent claim could amount to breach of section 17 of the Marine Insurance Act 1906 (extracted in chapter 4) thereby entitling the insurer to avoid the contract ab initio, this was disapproved by the House of Lords in The Star Sea (below [1102]). The issue is fundamental. Are insurers entitled to avoid the whole contract ab initio where there is a fraudulent claim? Or, can they only repudiate as from the date of the breach of duty? Or, are insurers restricted to merely repudiating the particular claim? [1101] Howard N Bennett ‘Mapping the Doctrine of Utmost Good Faith in Insurance Contract Law’ [1999] LMCLQ 165

‘4. Conclusions on the Marine Insurance Act 1906, section 17 as a basis for a general post-formation duty of utmost good faith On careful analysis, none of the three pillars on which Hirst J [in The Litsion Pride [1985] 1 Lloyd’s Rep 437], sought to build a general post-formation duty of utmost good faith founded on the Marine Insurance Act 1906, section 17 are solid. Whether the order for ship’s papers was based upon the doctrine of utmost good faith at all is doubtful. Even if it was, the order lacked the reciprocity stipulated by section 17 and breach did not trigger the remedy of retrospective avoidance which section 17 stipulates is available. A duty of utmost good faith does attach to held covered clauses, but it is suggested that breach does not entitle the insurer to the remedy of avoidance of the entire contract. The fraudulent claims jurisdiction provides the best foundation in that avoidance is available as a remedy. Currently, however, the reasoning in Skandia that section 17 is exhaustive with respect to remedies is incompatible with the cases affording the insurer a range of remedies, although it is argued above that such reasoning is erroneous. In truth, the three pillars relied on by Hirst J, lead to two conclusions. First, the authorities on held covered clauses and the fraudulent claims jurisdiction demonstrate that the doctrine of utmost good faith clearly has a post-formation dimension. Secondly, their differences in scope, standard of required behaviour and remedies for breach demand flexibility from the post-formation doctrine. If the authorities on orders for ship’s papers are properly regarded as an aspect of the post-formation doctrine, the diversity of the duties within that doctrine is merely accentuated. However, with or without the ship’s papers cases, the requisite diversity cannot be accommodated within section 17. The solution is to sever the post-formation doctrine from the strait-jacket of section 17 altogether, confining that provision to governing the reciprocal pre-formation duties

owed by the assured and insurer. Once that step is taken, the various duties to which the post-formation doctrine gives rise can be developed according to their own dictates. It is, moreover, suggested that neither statute nor precedent inhibits the latter approach. It is true that the wording of section 17 is sufficiently broad to encompass the post-formation duties, but equally its wording does not compel its application to the postformation duties. Indeed, the proposition in section 17 that insurance contracts are “based upon” the utmost good faith may be read as indicating that section 17 is concerned with the formation of the contract as opposed to its subsequent operation. Moreover, section 17 is the first in a group of sections of the Marine Insurance Act headed “Disclosure and Representations”, consisting of sections 17–21. Apart from section 17 itself, the wording of the other four sections unequivocally confines their scope to the initial formation of the contract. Sections 18–20 have been discussed earlier. Section 21 is concerned with offer and acceptance. The context may, therefore, suggest that section 17 should likewise be confined to the pre-formation stage. With respect to precedent, very few judgments attach postformation duties to five. 17 and the point has not been the subject of argument. Thus, in The Litsion Pride the application of section 17 to the post-formation doctrine, although endorsed by Hirst, J was, common ground between the parties. In The Good Luck the adoption of the reasoning of the Court of Appeal in Skandia implicitly involves applying section 17 to the post-formation doctrine, but the legitimacy of this application was not in dispute. Consequently, it is suggested that the post-formation duty should fall outside of section 17 altogether. Two benefits in particular would flow from severance. First, severance would permit the courts to mould the remedy to the context just as they have sensibly moulded the content of the duty. As already noted, section 17 is

inflexible with respect to remedies for breach. Any breach of a duty falling within section 17 affords the innocent party the right retrospectively to avoid the contract. The severity of this remedy is justifiable in the context of fraudulent claims. However, the fraudulent claims jurisdiction can support the remedy of retrospective avoidance without the assistance of section 17. By contrast, it has been argued above that retrospective avoidance of the entire contract is unjustifiable in the context of held covered clauses and compromises of claims. Consequently, remedial flexibility is required. This can be produced only by reading section 17 either as restricted to certain aspects of the post-formation duty or as not applying to the post-formation doctrine at all. The former reading is difficult to reconcile with the wording of section 17. If the section does apply to the post-formation doctrine, it would seem to apply to all aspects of the postformation doctrine. Severing the post-formation doctrine from section 17 altogether would permit each duty to which the post-formation gives rise to support such remedy, or range of remedies, for breach as was appropriate to the duty in question. Secondly, severing the post-formation doctrine of utmost good faith from section 17 may facilitate the elucidation of a satisfactory juristic basis. The principal characteristic of the various duties to which the post-formation doctrine does, or may, give rise is a lack of homogeneity. Following the suggestion of the Court of Appeal in The Star Sea, it may, be inappropriate to search for a single juristic basis for all aspects of the post-formation doctrine. The law of assignment supports a contractual analysis, and the key to the juristic bases of the duties within the post-formation doctrine may lie in the flexibility of the implied term in law, with each duty being supported by a separate implied term. While the doctrine of utmost good faith may provide the legal basis for implying the relevant terms, it does not have to dictate their scope, the standard of required conduct or

the remedies for breach. Each duty could be the subject of a separate implied term, the precise facets of which could be left to the courts to mould as appropriate to the particular duty. Thus, were it thought that breach of a particular duty should give rise to a damages remedy, the implied term on which that duty was based could be declared to be promissory without prejudice to the contingent nature of implied terms supporting other duties within the overall doctrine. It might, for example, be argued that a strict liability duty attaching to the claims handling process would be the most effective way of combating bad faith practice by insurers, but only if breach were to sound in damages. Ultimately, the function of the doctrine of utmost good faith in insurance contract law is to provide a legal basis for the implication by law of a number of contractual terms of diverse properties appropriate to the context and function of the term in question. E. SUMMARY AND CONCLUSIONS A central theme of this article is that the rhetoric of “utmost good faith” must never substitute for a careful consideration of what is good law in the particular and modern context. The Statements of Practice of the Association of British Insurers constitute an acceptance by the insurance industry that the traditional principles of insurance contract law, developed when the industry was dominated by commercial policies of marine insurance, are not appropriate for all sectors of the modern industry. The future development of the doctrine of utmost good faith must take place against an evaluation of the extent to which it continues to be appropriate for parties to insurance contracts, in practice usually the insurers, to occupy a privileged position as opposed to all other contracting parties and litigants.

It may be useful to summarise the main arguments advanced. 1. The Marine Insurance Act 1906, section 17 provides expressly for the remedy of avoidance of the contract for breach. This means retrospective avoidance of the entire contract. The extent to which section 17 should be viewed as the basis of all aspects of the doctrine of utmost good faith depends on whether some measure of flexibility in the remedies for breach or standard of conduct is viewed as appropriate. 2. Section 17 is the basis of the entirety of the reciprocal pre-formation duties of utmost good faith resting upon the insurer and assured. Sections 18 and 20 to the extent that it applies to the assured provide details of the two main aspects of the assured’s preformation duty under section 17. 3. Outside of and independently from the assured’s duty of utmost good faith, an insurer is entitled to avoid the policy for pre-formation non-disclosure under section 19 and misrepresentation under section 20 by an agent to insure. In all probability, this aspect of the pre-formation doctrine does not fall within section 17. 4. The reasoning of the Court of Appeal in Skandia reveals a tenable justification for denying a damages remedy for breach of the duty of utmost good faith. However, breach of a contractual term implied in law need not sound in damages. The wording of the Marine Insurance Act, previous authority and the origin of the doctrine of utmost good faith are all perfectly compatible with an implied term basis for the duty. The law of assignment supports such an analysis. The doctrine of utmost good faith developed by the common law courts and codified in the Marine Insurance Act is a common law doctrine and the juristic basis of the duties generated by the preformation doctrine is a contractual contingent condition

5.

6.

7.

8.

9.

precedent to the enforceability of the contract implied in law. The heterogeneity of the various duties to which the postformation doctrine of utmost good faith gives rise requires flexibility in scope, standard and remedies. The unequivocal availability of retrospective avoidance as a remedy for any breach of section 17 denies any possibility of remedial flexibility. Consequently, it is suggested that the post-formation doctrine of utmost good faith lies entirely outside section 17. The flexibility required by the heterogeneity of the various duties generated by the post-formation doctrine requires also a flexible juristic basis for the doctrine. The law of assignment again supports a contractual basis. Accordingly, each duty within the post-formation doctrine may be the subject of a separate contractual term implied in law, the precise properties of which may be moulded by the courts as appropriate to the duty in question. In principle, the post-formation doctrine of utmost good faith attaches to all terms of insurance contracts under which the assured is required by the policy to give the insurer information relevant to fixing the terms on which cover is granted or to be extended and to the making of claims. Outside of such matters, however, there is no duty to disclose information simply because it would be of value to the insurer. With respect to the giving of information or notice pursuant to express contractual terms, such as held covered clauses, the post-formation duty is strict liability in nature but moulds itself to its context in terms of scope and, it is suggested, remedy. Breach entitles the insurer to avoid such extension of cover as the insurer has been induced to grant by the breach. The development of the order for ship’s papers is consistent with a doctrine of utmost good faith but the

order was probably not part of the doctrine. It was certainly no part of the section 17 duty of utmost good faith. 10. The fraudulent claims jurisdiction is part of the postformation duty of utmost good faith. An assured who makes a fraudulent claim is liable, at the insurer’s option, to forfeit the entire benefit of the policy. The insurer has the choice either to reject the entire claim, even if the fraud affects only part, or retrospectively to avoid the entire policy. It is possible also that a fraudulent claim may constitute a repudiatory breach of contract so that the insurer also has the option to elect to treat his liability under the contract as prospectively discharged. 11. The apparent harshness of a retrospective remedy in the event of a fraudulent claim is fully justified in all areas of insurance by the policing function of the doctrine of utmost good faith in that particular context. However, the argument that the realities of insurance practice justify a strict liability duty at the claims stage attracting a retrospective remedy is not immediately apparent in the modern world. 12. If the duty attaching to the making of claims is confined to the avoidance of fraud, a strict liability duty of utmost good faith may still attach to contracts of compromise of claims on insurance policies, although there is little authority for such a duty at present and, again, it is not immediately apparent why compromises of insurance contracts should be singled out for special treatment. Any such duty, if broken, should permit avoidance only of the compromise, not the entire policy.’

[1102] Manifest Shipping Co Ltd v Uni-Polaris Shipping Co Ltd (The Star Sea) [2001] 2 WLR 170 (HL)

[The insured’s ship was destroyed by fire. insurers defended the claim on the ground during negotiations after the loss the insured failed to disclose facts relating to similar fires had damaged other ships also owned by him.]

The that had that

Lord Hobhouse: ‘Before your Lordships the defendants contended that there was a positive duty of fair dealing and disclosure any breach of which would amount, in effect, to constructive fraud giving rise to the section 17 remedy of an entitlement to avoid the contract. But the defendants also had to contend that the duty extended up to and included the pursuit of any claim in litigation since this was the stage at which the matters upon which they relied had occurred. Thus, the defendants argued that it was a breach of that duty for the assured to claim privilege for a document which might assist the insurer to resist the claim… …[B]oth Counsel submitted that the utmost good faith is a principle of fair dealing which does not come to an end when the contract has been made… There are many judicial statements that the duty of good faith can continue after the contract has been entered into… However, as will also become apparent from the citation, the content of the obligation to observe good faith has a different application and content in different situations. The duty of disclosure as defined by sections. 18 and 20 only applies until the contract is made. …[B]oth Counsel accept and assert that the conclusion of the Court of Appeal in the Banque Keyser case [see chapter 4, [424]] is good law and that there is no remedy in damages for any want of good faith. Counsel also drew this conclusion from the second half of section 17 — “may be avoided by the other party”. The sole remedy, they submitted, was avoidance. It follows from this that the

principle relied upon by the defendants is not an implied term but is a principle of law which is sufficient to support a right to avoid the contract of insurance retrospectively… The right to avoid referred to in section 17…applies retrospectively. It enables the aggrieved party to rescind the contract ab initio. Thus he totally nullifies the contract. Everything done under the contract is liable to be undone. If any adjustment of the parties’ financial positions is to take place, it is done under the law of restitution not under the law of contract. This is appropriate where the cause, the want of good faith, has preceded and been material to the making of the contract. But, where the want of good faith first occurs later, it becomes anomalous and disproportionate that it should be so categorized and entitle the aggrieved party to such an outcome. But this will be the effect of accepting the defendants’ argument. The result is effectively penal. Where a fully enforceable contract has been entered into insuring the assured, say, for a period of a year, the premium has been paid, a claim for a loss covered by the insurance has arisen and been paid, but later, towards the end of the period, the assured fails in some respect fully to discharge his duty of complete good faith, the insurer is able not only to treat himself as discharged from further liability but can also undo all that has perfectly properly gone before. This cannot be reconciled with principle… A coherent scheme can be achieved by distinguishing a lack of good faith which is material to the making of the contract itself (or some variation of it) and a lack of good faith during the performance of the contract which may prejudice the other party or cause him loss or destroy the continuing contractual relationship. The former derives from requirements of the law which preexist the contract and are not created by it although they only become material because a contract has been entered into. The remedy is the right to elect to avoid the contract. The latter can derive

from express or implied terms of the contract; it would be a contractual obligation arising from the contract and the remedies are the contractual remedies provided by the law of contract. This is no doubt why Judges have on a number of occasions been led to attribute the post-contract application of the principle of good faith to an implied term. The principle relied on by the defendants is a duty of good faith requiring the disclosure of information to the insurer. They submit that the obligation as stated in section 17 continues throughout the relationship with the same content and consequences. Thus, they argue that any nondisclosure at any stage should be treated as a breach of the duty of good faith: it has the same essential content and gives rise to the same remedy — the right to avoid… …[The] authorities show that there is a clear distinction to be made between the precontract duty of disclosure and any duty of disclosure which may exist after the contract has been made. It is not right to reason, as the defendants submitted that your Lordships should, from the existence of an extensive duty pre-contract positively to disclose all material facts to the conclusion that post-contract there is a similarly extensive obligation to disclose all facts which the insurer has an interest in knowing and which might affect his conduct. The Courts have consistently set their face against allowing the assured’s duty of good faith to be used by the insurer as an instrument for enabling the insurer himself to act in bad faith. An inevitable consequence in the post-contract situation is that the remedy of avoidance of the contract is in practical terms wholly one-sided. It is a remedy of value to the insurer and, if the defendants’ argument is accepted, of disproportionate benefit to him; it enables him to escape retrospectively the liability to indemnify which he has previously and (on this hypothesis) validly undertaken…

Fraudulent claims

This question arises upon policies which up to the time of the making of the claim are to be assumed to be valid and enforceable. No right to avoid the contract had arisen. On ordinary contractual principles it would be expected that any question as to what are the parties’ rights in relation to anything which has occurred since the contract was made would be answered by construing the contract in accordance with its terms, both express and implied by law. Indeed, it is commonplace for insurance contracts to include a clause making express provision for when a fraudulent claim has been made. But it is also possible for principles drawn from the general law to apply to an existing contract — on the better view, frustration is an example of this as is the principle that a party shall not be allowed to take advantage of his own unlawful act. It is such a principle upon which the defendants rely in the present case. As I have previously stated there are contractual remedies for breach of contract and repudiation which act prospectively and upon which the defendants do not rely. The potential is also there for the parties, if they so choose, to provide by their contract for remedies or consequences which would act retrospectively. All this shows that the Courts should be cautious before extending to contractual relations principles of law which the parties could themselves have incorporated into their contract if they had so chosen… Where an insured is found to have made a fraudulent claim upon the insurers, the insurer is obviously not liable for the fraudulent claim…The law is that the insured who has made a fraudulent claim may not recover the claim which could have been honestly made. The principle is well established and has certainly existed since the early nineteenth century…The logic is simple. The fraudulent insured must not be allowed to think: if the fraud is successful, then I will gain; if it is unsuccessful, I will lose nothing.

In Goulstone v Royal Insurance Co (1858) 1 F & F 276, which concerned a fire policy and a plea that the claim was fraudulently exaggerated, Pollock, CB directed the jury that if the claim “was wilfully false in any substantial respect”, they should find for the defendant as the plaintiff had in that case “forfeited all benefit under the policy” (p 279). In Britton v Royal Insurance Co (1866) 4 F & F 905, also a fire insurance case where it was alleged that the insured took advantage of the fire to make a fraudulent claim, Mr Justice Willes directed the jury: “The law upon such a case is in accordance with justice and also with sound policy. The law is, that a person who has made such a fraudulent claim could not be permitted to recover at all. The contract of insurance is one of perfect good faith on both sides, and it is most important that such good faith should be maintained. It is the common practice to insert in fire policies conditions that they shall be void in the event of a fraudulent claim; and there was such a condition in the present case. Such a condition is only in accord with legal principle and sound policy. It would be most dangerous to permit parties to practise such frauds, and then, notwithstanding their falsehood and fraud, to recover the real value of the goods consumed. And if there is wilful falsehood and fraud in the claim, the insured forfeits all claim whatever upon the policy. This, therefore, was an independent defence; quite distinct from that of arson” (p 909). Mr Justice Willes stressed to the jury that it was of the utmost moment that insurances should be enforced fairly and protected from fraud (p 911). These authorities link the defence to the observation of good faith but are specifically based upon the actual fraud of the insured in making the claim. These judgments do not use the language of avoidance of the policy ab initio but

refer to the forfeiture of “all benefit under the policy” or “all claim” upon it. It seems that the language used at the time in express clauses was similar… Modern authorities have not however always adopted this analysis. In Orakpo v Barclays Insurance Services Ltd [1995] LRLR 443, the insurance covered damage to a building. The insurance contract was in any event voidable since it had been induced by material misrepresentation but the defendant insurance company had also relied upon the defence that the claim was grossly exaggerated and fraudulent. In the Court of Appeal the defence was apparently argued upon the basis of implied term on the assumption that the continuing duty of good faith should be so analysed. The appellant plaintiff was appearing in person. The Court of Appeal dismissed his appeal holding unanimously that there had been a misrepresentation. But, obiter, there was a difference of opinion on the fraudulent claim defence. Lord Justice Staughton, dissenting, was of the opinion that any breach of an implied term or, the duty of good faith would not have been so fundamental as to entitle the insurer to be discharged from liability. The majority, Lord Justice Hoffmann and Sir Roger Parker, held that the insurer would on that ground as well have had a defence to the whole of the claim. The decision of Lord Justice Hoffmann was arrived at applying contractual principles: he was concerned with an implied term (p 451): “…Any fraud in making the claim goes to the root of the contract and entitles the insurer to be discharged. One should naturally not readily infer fraud from the fact that the insured has made a doubtful or even exaggerated claim. In cases where nothing is misrepresented or concealed, and the loss adjuster is in as good a position to form a view of the validity or value of the claim as the insured, it will be a legitimate reason that the assured was merely putting forward a starting figure for negotiation. But in cases in

which fraud in the making of the claim has been averred and proved, I think it should discharge the insurer from all liability.” …Sir Roger Parker said, at p 452: “The appellant submits that the law, in the absence of a specific clause, is that an insured may present a claim which is to his knowledge fraudulent to a very substantial extent, but may yet recover in respect of the part of the claim which cannot be so categorized. To accept this proposition involves holding that, although an insurance contract is one of utmost good faith, an assured may present a positively and substantially fraudulent claim without penalty, save that his claim will to that extent be defeated on the facts…I can see…every reason why he should not recover at all.” …These dicta do not assist the defendants in the present case on the critical point whether anything less than actual fraud in the making of the claim brings the principle into play. Counsel have assured your Lordships that in the present case nothing turns upon whether the claim is wholly forfeit or the whole policy is treated as forfeit as well. The authority of Britton is that the whole claim is forfeit, which was what was material in the Orakpo case. As regards the question, academic in the Orakpo case and academic in the present case save as a pleading point, whether the making of a fraudulent claim would entitle the insurer to avoid the contract ab initio, that is a point upon which the judgments in Orakpo cannot be treated as fully authoritative in view of the contractual analysis there adopted. The language of Mr Justice Hoffmann is fully justified on that contractual analysis — “goes to the root of the contract and entitles the insurer to be discharged”. The fraud is fundamentally inconsistent with the bargain and the continuation of the

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

submission that something less than a fraudulent claim will suffice to give the insurer a defence. The other decision is that of Mr Justice Rix in Royal Boskalis Westminster NV v Mountain [1997] LRLR 523, reversed on grounds which do not affect the value of the judgment of Mr Justice Rix in relation to the principle of good faith at pp 591 et seq. He powerfully questions whether in relation to claims the right of the insurer to repudiate all liability can extend beyond the making of a fraudulent claim to an innocent failure to disclose. He points out the difficulties which would arise in relation to the test of materiality and remedy. Again, the judgment underlines the relevance of fraud… Finally, mention should be made of the judgment of Mr Justice Hirst in The Litsion Pride [above] which has been used in a number of cases to support a general view of the post contract duty of good faith. It was an exceptional case in that it involved a war risks policy under which the insured shipowners were entitled to send their ship into a highly dangerous war risk zone in the Persian Gulf against an obligation to pay a heavy additional premium calculated on the length of time spent in the zone. The policy, however did not require the shipowner to declare in advance that the ship was entering the zone but permitted declarations after it had done so. As a result the shipowners had a strong motive only to declare the entry if the vessel suffered a loss and that is what they did. Mr Justice Hirst held that this practice was not a breach of contract but was done with the fraudulent intent of depriving the insurer of the additional premiums to which it was entitled. He held that the insurer was not liable to pay the claim. There had been a breach of the duty of good faith. The remedy was not confined to electing to avoid the policy; the insurer had elected not to avoid it. The insurer was entitled to rely on the breach as giving it a defence to the claim of the mortgagee of the vessel, the only effective plaintiffs in the action. The

particular claim was only fraudulent in so far as the broker had not been truthful in dealing with the insurers at that stage. The reasoning adopted by Mr Justice Hirst has been criticized both by academic writers and by other Judges in later cases. I consider that it should not any longer be treated as a sound statement of the law. In so far as it decouples the obligation of good faith both from section 17 and the remedy of avoidance and from the contractual principles which would apply to a breach of contract it is clearly unsound and cannot survive the Court of Appeal judgment in Banque Keyser, upheld by your Lordships’ House. In so far as it is based upon the principle of the irrecoverability of fraudulent claims, the decision is questionable upon the facts since the actual claim made was a valid claim for a loss which had occurred and had been caused by a peril insured against when the vessel was covered by a held covered clause. It is not necessary to examine whether there might or might not have been some other basis upon which the case could be decided in favour of the insurer as one feels it clearly ought to have been. But what is clear is that the judgment of Mr Justice Hirst is not a sound basis for the arguments advanced by the defendants in the present case. For the defendants to succeed in their defence under this part of the case the defendants have to show that the claim was made fraudulently. They have failed to obtain a finding of fraud…The claim was in fact a good one which the owners were, subject to quantum, entitled to recover under the policy. The defendants were liable to pay it. The policy was valid and enforceable. For the defendants successfully to invoke section 17 so as to avoid the policy ab initio and wholly defeat the claim would be totally out of proportion to the failure of which they were complaining. Fraud has a fundamental impact upon the parties’ relationship and raises serious public policy considerations. Remediable mistakes do not have the same character…

In litigation The point here is whether the obligation of good faith and disclosure continues to apply unqualified once the parties are engaged in hostile litigation before the Courts. There is no authority directly on this point. It was decided in favour of the owners by both Courts below. There are however dicta in cases which show that the Judges concerned contemplated that the obligation of good faith could continue to apply during litigation… Before the litigation starts the parties’ relationship is purely contractual subject to the application of the general law. If one party has a right such as that given by section 17 it derives from the contract itself or from the application of the general law to the contractual relationship. These rights continue unimpaired unless one party has exercised a right of avoidance or termination. The insured has or may have a claim against the insurer. The insurer may have accepted the claim or may have rejected it. The insurer may have done so in a manner which evinces an intention not to be bound by the contract or, more probably, may simply be requiring to be satisfied that there is a valid claim covered by the policy. But the insured will either have or not have a cause of action against the insurer… When a writ is issued the rights of the parties are crystallized. The function of the litigation is to ascertain what those rights are and grant the appropriate remedy. The submission of the defendants in this case is that, notwithstanding this, one party’s conduct of the litigation can not only change that party’s substantive rights but do so retrospectively avoiding the contract ab initio. It cannot be disputed that there are important changes in the parties’ relationship that come about when the litigation starts. There is no longer a community of interest. The parties are in dispute and their interests are opposed. Their relationship and rights are now governed by the rules of procedure and the orders which the Court makes on the application of one

or other party. The battle lines have been drawn and new remedies are available to the parties. The disclosure of documents and facts are provided for with appropriate sanctions; the orders are discretionary within the parameters laid down by the procedural rules. Certain immunities from disclosure are conferred under the rules of privilege. If a party is not happy with his opponent’s response to his requests he can seek an order from the Court. If a judgment has been obtained by perjured evidence remedies are available to the aggrieved party. The situation therefore changes significantly. There is no longer the need for the remedy of avoidance under section 17; other more appropriate remedies are available… …The section 17 principle is a principle of law and if its rationale no longer applies and if its operation, the conferment of a right of avoidance, ceases to make commercial or legal sense then it should be treated as having been exhausted or at the least superceded by the rules of litigation. It will also very often be the case that by the time the litigation has started the cover has expired or its subject matter has ceased to exist so as to make the continuing relationship of insurer and insured no longer current and the observation of good faith only significant to the litigation. I am therefore strongly of the view that once the parties are in litigation it is the procedural rules which govern the extent of the disclosure which should be given in the litigation, not section 17 as such, though section 17 may influence the Court in the exercise of its discretion. The cases upon ship’s papers, far from supporting the continuing application of the duty of good faith in truth support the opposite conclusion. As previously discussed, the fact that orders for ship’s papers were only made in marine insurance despite the fact that the principle of good faith applies to all insurance and the fact that the order was a matter of discretion not of right shows that it is a

procedural remedy not a matter of contract although the principle of good faith clearly influenced the attitude of the Court to making such an order. But, most conclusively, the fact that the remedy was to obtain an order from the Court and not to avoid the contract shows both the limits of the principle and the change of relationship which comes about when the parties are in hostile litigation…

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

Notes: 1. See B. Soyer, “The Star Sea — a lone star?” [2001] LMCLQ 428. 2. The conclusion that can be drawn from The Star Sea is that as far as claims are concerned, the

duty of the insured is one of honesty only. Commenting on the decision, Birds and Hird (Birds’ Modern Insurance Law (London, Sweet & Maxwell, 2001) p 256) observe that: ‘It may be that there is no general continuing duty of utmost good faith, at least as regards disclosure, and as far as claims are concerned, any duty is not broken by an innocent or negligent non-disclosure.’ The authors add (see n 5, p 256) that ‘it was held that any duty with regard to claims ceased once legal proceedings were commenced, so that exaggerated assessments of loss in the statement of claim were not a breach of duty…’ (see the speech of Lord Hobhouse, above). This is also the position in most USA jurisdictions where it has been explained as being based upon the fact that once the insured and the insurer become involved in litigation they are adversaries and they ‘no longer deal on the non-adversarial level required by the contract’: American Paint Service Inc v Home Insurance Co 246 F 2d 91 (3d Cir 1957). 3. The failure of the House of Lords to take the opportunity to clarify once and for all the scope of the post-contract duty of good faith has meant that the issue continues to be litigated (see The “Mercandian Continent”, below, [1103]) Not surprisingly, Mance LJ in Agapitos v Agnew (below, [1105]) called for legislative intervention.

[1103] 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’) [2001] Lloyd’s Rep IR 802 (CA) [The insured had written a fraudulent letter during negotiations following a claim under a liability insurance policy. Following the insured’s insolvency the insurers were defending a claim that had been brought against the insured (thus, on the facts it was not a claim by the insured). The letter in question was found to be immaterial to the claim. The Court of Appeal, holding the insurer liable, aligned the duty of disclosure during the claims process with its precontract counterpart, ie. the non-disclosed or misrepresented fact had to be material and the insurer needs to demonstate inducement]. Longmore LJ: ‘In this appeal from Aikens J the Court is concerned with the ambit of section 17 of the Marine Insurance Act 1906… The extent to which this section applies once a contract of insurance has been concluded has never been authoritatively determined, but it has recently been considered by the House of Lords in Manifest Shipping Co Ltd v Uni-Polaris Insurance Co (The Star Sea) [above]…The House held that culpable non-disclosure was insufficient to attract the drastic consequence of avoidance provided by section 17. The result was that the insured shipowner could recover under the insurance policy despite such culpable non-disclosure and a consequent purported avoidance by the insurers…

The Marine Insurance Act, 1906 was and is a codification of the law of marine insurance. The law as there stated is, in general, no different from that for other forms of insurance in so far as the duties in relation to good faith, disclosure and representations are concerned. Generally speaking again, the duties to disclose material matters and not to make material misrepresentations apply before the contract is concluded and do not continue after the contract is concluded. An insurer is not able to require disclosure of matters which show he has made a bad bargain. One question that has arisen is whether there is a continuing duty to disclose material matters, if the insurer is entitled to cancel the policy by serving a notice of cancellation. This Court held in New Hampshire Insurance Co v Mirror Group Newspapers Ltd [1997] LRLR 24 that there was not. Staughton LJ gave the judgment of the Court; he set out section 17 of the Act and the requirement in section 18(1) that the assured must disclose, before the contract is concluded, every material circumstance known to the assured…Staughton LJ then recorded a submission that section 18(1) was merely one example of the general duty that was placed upon both parties at all times by section 17 and said: “We can see force in that argument. But it is questionable whether in practice the law has been treated in that way.” I would respectfully echo that sentiment. In the light of this remark and the Judge’s conclusion that the duty of good faith only applies post-contract if the insurer is invited to renew or vary his speculation or risk or if the insured is pursuing a claim under the policy, it is necessary to trace the development of this area of the law in a little detail…

Development of the law of post-contract good faith (1) Fraudulent claims

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

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

to bring the contract to an end could only be material fraud. It is in this way that the law of post-contract good faith can be aligned with the insurers’ contractual remedies. The right to avoid the contract with retrospective effect is, therefore, only exercisable in circumstances where the innocent party would, in any event, be entitled to terminate the contract for breach. The desirability of aligning the right to avoid with the right to terminate the contract for breach is self-evident. It is often observed that the right of avoidance is disproportionate (see the speech of Lord Hobhouse, paras 61 and 72). If the right to avoid in a post-contract context is exercisable only when the right to terminate for breach has arisen, the disproportionate effect of the remedy will be considerably less and the extra advantages given to insurers when they exercise a right of avoidance (eg nonliability for earlier claims) will be less offensive than they otherwise would be. The requirement of materiality has, of course, always been required for avoidance for lack of pre-contract good faith. More significantly, it is also a requirement for the operation of the rule about fraudulent claims. The case of Goulstone v Royal Insurance Co (1858) 1 F & F 276 is instructive [see Lord Hobhouse’s speech in the The Star Sea, above, [1102]]…Chief Baron Pollock said to the jury that the plaintiff’s interest was nevertheless legally insurable, whether or not the creditors ought to have the benefit of the insurance. He continued: “But the question is whether the claim [viz. the claim on insurers] was fraudulent i.e. whether it was wilfully false in any substantial respect; for instance, as to private furniture which was sworn to be worth only £50 in 1894 and has not since been added to.”

The Chief Baron is there drawing a distinction between the material and substantial fraud in the claim on underwriters in respect of the over-valuation of the furniture and the immaterial fraud of concealing the linen and china from the creditors… In the context of deliberate and culpable (but not fraudulent) post- contract conduct, Rix J in Royal Boskalis [[1997] LLRR 523] said that a fact would only be material if it had ultimate legal relevance to a defence under the policy…and Aikens J has adopted that as the appropriate test of materiality where fraud has been proved… Aikens J expressed his conclusion as to the law in that and the following paragraph of his judgment. His view was that there was a continuing duty on the assured to refrain from a deliberate act or omission intended to deceive the insurer through either positive misrepresentation or concealment of material facts and facts would only be material for the purpose if they had ultimate legal relevance to a defence under the policy. I agree with the Judge’s conclusion summarised in this way save that I would also add (even if it is usually or invariably to state the same conclusion in different words) that the insurers cannot avoid the contract of insurance for such fraudulent conduct unless the conduct was such as to justify their terminating the contract in any event. If and in so far as Aikens J was intending to go further than this and say that the insurers’ defence of bad faith was inapplicable because no “good faith occasion” had arisen…I would not agree, since it seems to me that the duty not to be materially fraudulent does continue at all times after the contract has been made. To this extent, therefore, I would reject Mr Rainey’s submission that there are only some occasions when the requirement of good faith exists post-contract and accept Mr Hirst’s submission that the duty is a continuing one. If, however, I am wrong about that and there are defined categories of good faith arising post-contract, I would

conclude that the giving of information, pursuant to an express or implied obligation to do so in the contract of insurance, is an occasion when good faith should be exercised. Since, however, the giving of information is essentially an obligation stemming from contract, the remedy for the insured fraudulently misinforming the insurer must be commensurate with the insurer’s remedies for breach of contract. The insurer will not, therefore, be able to avoid the contract of insurance with retrospective effect unless he can show that the fraud was relevant to his ultimate liability under the policy and was such as would entitle him to terminate the insurance contract.

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

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

Notes: 1. Taking The Star Sea and The Mercandian Continent together, the judicial consensus seems to be that if a claim is dishonest the insurers can avoid it on the basis of the common law rule prohibiting a person benefiting from his or her own wrong. The reasoning in The Star Sea suggests that the insured’s fraud does not entitle the insurer to the additional right to avoid the policy ab initio for breach of a continuing duty under section 17. Rather, the fraud results in all benefits under the policy being forfeited by the insured. 2. A further issue that has recently arisen is what is the position with respect to co-insurance where a fraudulent claim is made by one insured but not the other? [1104] Direct Line Insurance plc v Khan [2002] Lloyd’s Rep IR 364 [The facts appear from the judgment] Arden LJ: ‘The facts are that Mrs Khan and her husband own 22 Camborne Way, Hounslow. On 23 July 1999 Mrs Khan took out a policy of insurance on the house and contents with the respondent in this appeal (“Direct Line”). Under the policy her husband was named as a joint policyholder and the interest of Barclays as mortgagee was noted…

On 8 January 2000 a fire occurred at the property and Mr and Mrs Khan lost certain of their possessions and had to move out. At all material times Mr and Mrs Khan have lived together as man and wife, but following the fire Mrs Khan has been depressed and the insurance claims arising out of the fire have been made by Mr Khan on behalf of them both. Mr Khan made a claim under the policy for rent alleged to be payable for alternative accommodation at 68 Standard Road, Hounslow. He pretended that the property belonged to a friend, Mr Gabriel, and he forged a receipt for rent and a deposit, alleged to have been paid to Mr Gabriel for this accommodation. He also proffered a false rental agreement to Direct Line. The rent was duly repaid by Direct Line. In point of fact no rent was payable because Mr Khan owned this property and Direct Line, therefore, brought these proceedings seeking summary judgment to recover all monies paid in respect of the fire, including payments for reinstatement of the property. Direct Line have made payments under the policy as follows: the reinstatement of the buildings £43,425.90; replacement of the contents, £18,915.95 and rent payable in respect of the alternative accommodation, 68 Standard Way, Hounslow, £8,257.47. Direct Line relies on the principle that an insured loses all right to recover in respect of a policy if a material part of the claim, that is a non de minimis part of the claim, which he makes is fraudulent (see Galloway v Guardian Royal Exchange UK Ltd [1999] Lloyds Reports 209 [considered by Lord Hobhouse, above, [11.2]]). The judge applied the principle in the Galloway case. He rejected the argument that Mr Khan could have claimed for rental lost on 68 Standard Road as a result of having to use it for accommodation for himself and his wife and as a result of it therefore being no longer available for rent, as the claim which was made was for rent and it was made dishonestly.

The judge rejected the argument that Mrs Khan was the sole policyholder and rejected the argument that she should be able to recover on the basis that the fraud had been committed by her husband without her knowledge… On this appeal, therefore, Mr Andrew Nicol, who appears for Mrs Khan, makes the following submissions: first, he submits that even if the policy was a joint policy Mrs Khan should be able to recover on the different heads of claim arising out of the fire because she did not know that the claim was put forward dishonestly; and secondly he relies on the Unfair Terms in Consumer Contract Regulations 1994. The court made it clear to counsel that for the purposes of the first submission which Mr Nicol made the court was prepared to assume, without of course deciding it, that the policy was a separate policy in respect of Mrs Khan’s interest. Mr Nicol submits persuasively that whether the policy insures joint or several interests, Mrs Khan, who is innocent of any fraud, should be able to recover on the other heads as a matter of policy. He submits that this is the modern approach… Mr Nicol criticises a policy in the law which penalises Mrs Khan. He submits that it is a flawed policy and results in a disproportionate penalty on her as an innocent party. The difficulty about this argument…is that the court is in my judgment bound by the Galloway case to which I have referred above… …Mr Nicol submits that the Galloway case can be distinguished because there the fraud included fraud at the inception of the policy, and no agency relationship was involved. He submits that that is what led the Court of Appeal in that case to conclude that the contract was void ab initio. Mr Nicol then took us to [The Star Sea] to show us that it may be too extreme a view to say that the contract of insurance is avoided ab initio. The Star Sea case was not a case of a fraudulent claim but of culpable non-disclosure…

So too in this case there is no need for the court to distinguish between an avoidance of the contract ab initio and something which would defeat the claim arising out of the fire in January 2000. This is not a case where there was some prior claim which was duly settled which the insurers were trying to recover. So, as I see it, there is nothing in the Manifest case which detracts from the authority of the Galloway case and, as I see it, that case cannot be distinguished on the ground that it included a fraud at the inception of the policy. That point simply played no part in the reasoning of the Court of Appeal since the consequences of the answer to the second preliminary question were not addressed… Mr Flenley appears on this appeal for the respondent…We have not called upon him, but we have had the benefit of his skeleton argument and indeed of the respondent’s notice which was put in on behalf of Direct Line. In that respondent’s notice Direct Line seeks to uphold the judge’s decision on the basis that Mr Khan’s actions which constituted fraudulent exaggeration of both the defendants’ insurance claims were actions which Mr Khan carried out partly on his own behalf and partly as agent for Mrs Khan within the scope of Mr Khan’s actual or apparent authority from Mrs Khan. Mrs Khan was, therefore, bound by the consequences of those fraudulent actions and that those consequences are as found by the judge. That contention in the respondent’s notice is supported in Mr Flenley’s skeleton argument. As I see it there is no answer to this point. The principles of agency law are well established and bind this court. There is one qualification that I must make, Mr Nicol put forward a submission that the principal is bound by the representations made by its agent, even if fraudulent, should not apply where there was a single policy simply as a matter of commercial convenience but, as Mr Nicol frankly accepted, there is no authority to

support this proposition and, therefore, it is not one which, in my judgment, can be applied here… Lastly, Mr Nicol relied on The Unfair Terms of Consumer Contracts Regulations 1994. Regulation 3 of these Regulations provide that subject to Schedule 1: “these Regulations apply to any term in a contract concluded between a seller or supplier and a consumer where the said term has not been individually negotiated.” 35. Paragraph (3) of Regulation 3 says: “For the purposes of these Regulations, a term shall always be regarded as not having been individually negotiated where it has been drafted in advance and the consumer has not been able to influence the substance of the term.” As I read these Regulations they do not apply to a situation where a contract is affected by a rule of law, even though the contract is made with a consumer and is otherwise within the purview of these Regulations. Such a term could not be described as one which has been “drafted in advance”. Moreover, I would find it a startling proposition if any rule of law could be reviewed under these Regulations. It seems to me to be well outside the purpose and spirit of the Regulations and might produce some surprising results. Moreover, so far as any unfairness is concerned it would have to take into account that the rule of law set out in the Galloway case is furtherance of a policy of discouraging fraudulent claims… So it is not simply a question of the rule preventing recovery of a benefit to which the policyholder was not entitled. The rule is also directed to deterrence and to discouraging false claims. Contrary to Mr Nicol’s submission, in my judgment this is a proper objective of the civil law in an appropriate case and this is one such case. A civil law

sanction, particularly a financial one, made in an appropriate case may be more effective than a criminal sanction or other sanction. In all these circumstances and for these reasons I would dismiss this appeal.’

Note: The uncertain state of the English law with respect to the duty of utmost good faith in relation to claims was recently subjected to thorough examination by the Court of Appeal in Agapitos (below). On the question of whether section 17 of the 1906 Act applies to fraudulent claims, Mance LJ (delivering the principal judgment) concluded that it did not (endorsing the reasoning of Bennett [above, [1101]]. As commented above, insurers cannot, therefore, avoid the policy ab initio for a fraudulent claim. In Agapitos the insured’s claim was genuine but was made by the use of fraudulent devices and means. The issue 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. [1105] Agapitos v Agnew [2002] Lloyd’s Rep IR 573 (CA) [This is a marine insurance decision. The insured ship was destroyed by fire caused by the carrying out of ‘hot works’ on the vessel. The policy contained a warranty forbidding such work. A subsequent endorsement permitted hot work but only following the issue of a Salvage Association certificate. The

insurers rejected the claim on the basis that the hot works that had caused the fire had been undertaken at a time when the warranty was in force and that in any case the work had been carried out in the absence of a certificate. During disclosure evidence emerged that hot works had been carried earlier than had been admitted by the assured. The insurers therefore applied to amend their defence so as to plead that the assured had falsely and fraudulently misrepresented the circumstances of the loss in breach of section 17 of the Marine Insurance Act 1906 so that the policy was avoided. Toulson J refused the application to amend on the basis that the insurers had a valid defence of breach of warranty and that any continuing duty of utmost good faith was discharged by the breach of warranty. The insurers appealed]. Mance LJ: ‘It has been said that the more cases there are endorsing a particular proposition, the shakier it may be (cf Posner, The Problems of Jurisprudence, Harvard University Press, p 83). The waves of insurance litigation over the last 20 years have involved repeated examination of the scope and application of any post-contractual duty of good faith. The opacity of the relevant principles — whether originating in venerable but cryptically reasoned common law cases or enshrined, apparently immutably, in section 17 of the Marine Insurance Act, 1906 — is matched only by the stringency of the sanctions assigned. Not surprisingly, recent clarification of aspects of these principles has been influenced by this stringency, particularly in the context of section 17: see eg, The Star Sea [above, [1102]]…and K/S

Merc-Scandia v Certain Lloyd’s Under-writers (The Mercandian Continent) [above, [1103]]. The older common law cases (particularly, Levy v Baillie (1831) 7 Bing. 349, Goulstone v Royal Insurance Co. (1858) 1 F & F 276 and Britton v Royal Insurance Co (1866) 4 F & F 905) stand for a rule of law, applicable even where there is no express clause in the policy, to the effect that an insured who has made a fraudulent claim forfeits any lesser claim which he could properly have made…It was unnecessary in The Star Sea to consider whether the whole policy is (at least if it is a marine policy) then also voidable, by application of or analogy with section 17…Nor did that issue arise in either of the modern decisions to which Lord Hobhouse there referred — Orakpo v Barclays Insurance Services Ltd [1995] LRLR 443, dicta in which Lord Hobhouse was careful not to endorse, and Galloway v Guardian Royal Exchange (UK) Ltd [1999] Lloyd’s Rep IR 209 (still more recently applied in this Court in Direct Line Insurance plc v Khan [2001] EWCA Civ 1794)… The present appeal raises for consideration (a) whether and in what circumstances the common law rule of law and/or section 17 can apply in the event of use of fraudulent means or devices (“fraudulent devices” for short) to promote a claim, which claim may prove at trial to be in all other respects valid, (b) whether (if so) the application of that rule and section ceases with the commencement of litigation and (c) whether, in the light of the answers to these questions, the Judge should have allowed the appellant insurers to amend their defence to assert (in short) that the respondents, during the course of the present litigation, maintained a case involving lying representations, as to the date when hot works commenced on the insured vessel… The scope and inter-relationship of the common law rule and section 17

In The Star Sea… Lord Clyde said that to confine section 17 to the pre-contract stage “now appears to be past praying for”. Lord Scott accepted the section’s postcontractual application…Lord Hobhouse, as I see it, proceeded on the same basis…Lord Justice Longmore commented in The Mercandian Continent that this Court should now proceed on that basis, and I for my part, while expressing the hope that the House of Lords judicially or Parliament legislatively might one day look at the point again, agree that we should do so. The fullest description of the common law rule appears in Britton in Mr Justice Willes’ summing up to the jury: “…The law is, that a person who has made such a fraudulent claim could not be permitted to recover at all. The contract of insurance is one of perfect good faith on both sides, and it is most important that such good faith should be maintained. It is the common practice to insert in fire-policies conditions such that they shall be void in the event of a fraudulent claim; and there was such a condition in the present case. Such a condition is only in accordance with legal principle and sound policy. It would be most dangerous to permit parties to practise such frauds, and then, notwithstanding their falsehood and fraud in the claim, to recover the real value of the goods consumed. And if there is wilful falsehood and fraud in the claim, the insured forfeits all claim upon the policy.” The simple rationale is in Lord Hobhouse’s words…in The Star Sea that: “The fraudulent insured must not be allowed to think: if the fraud is successful, then I will gain; if it is unsuccessful, I will lose nothing. The policy of the law to discourage the making of fraudulent claims…”

It is convenient at the outset to consider two points on which the scope of the common law rule is not entirely clear. The first is whether a claim, which is honestly believed in when initially presented, may become fraudulent for the purposes of the rule, if the insured subsequently realizes that it is exaggerated, but continues to maintain it. The second is whether the fraud must relate, in some narrow sense, to the subject matter of the claim, or may go to any aspect of its validity, including therefore a defence. The first point was left open by Lord Scott in The Star Sea…But I believe that the correct answer must be in the affirmative. As a matter of principle, it would be strange if an insured who thought at the time of his initial claim that he had lost property in a theft, but then discovered it in a drawer, could happily maintain both the genuine and the now knowingly false part of his claim, without risk of application of the rule… Further, if and in so far as the use of fraudulent devices may invoke the fraudulent claim rule — an issue to which I come at greater length below — it would again be artificial to distinguish between the use of such devices before and after the initial making of any claim. Such devices are a not unfamiliar response to insurers’ probing of the merits of a claim. The directions given and verdict entered by Mr Justice Roche in Wisenthal v World Auxiliary Insurance Corporation Ltd. (1930) 38 Ll L Rep 38 proceed on the basis that fraudulent devices used during the course of insurers’ investigation of a claim may invoke the common law rule, if otherwise applicable. As to the second point, a claim cannot be regarded as valid, if there is a known defence to it which the insured deliberately suppresses. To that extent, at least, fraud in relation to a defence would seem to me to fall within the fraudulent claim rule…I note only that none of the speeches in the House of Lords [in The Star Sea] contains any positive

suggestion that the common law rule or section 17 cannot apply to a known defence. I turn to examine the scope of the rule and the section more closely. Where there is a fraudulent claim, the law forfeits not only that which is known to be untrue, but also any genuine part of the claim. In contrast, where the use of fraudulent devices occurs, the whole claim is by definition otherwise good. The present appeal raises for consideration whether, as a matter of policy, the underlying rationale of the fraudulent claim principle should extend to invalidate not merely the whole of a claim where part proves good, but the whole of a claim where the whole proves otherwise good. The word “proves” of course assumes that all aspects of the litigation proceed to trial, which, although common, is not inevitable. The effect of the fraudulent claim principle is that, once it is determined (which it may be by trial of a preliminary issue) that part of a claim was false, the rest is forfeit, without it being essential to determine whether or not that rest itself related to genuine loss. If the use of fraudulent devices constitutes a defence to a claim, the possibility arises that this might be established by a preliminary issue, making trial of further issues irrelevant, so that, once again, it might never be determined whether genuine loss was suffered. Mr Popplewell, QC for the appellant insurers…argues persuasively that the rationale of the common law rule regarding fraudulently exaggerated claims has force in the wider context of use of fraudulent devices to promote an insurance claim. If an insured uses fraudulent devices to support a claim, he does so, normally, because he believes that it is necessary or expedient to do so. He uses such devices, precisely because he cannot be sure that his claim is otherwise good. Mr Popplewell therefore submits that it should be irrelevant for an assured to show subsequently that the claim was all along good or that his fraudulent devices were superfluous. If the deception succeeds, and

the insured wins, either at trial or because insurers settle on the basis that the facts were or may be as presented to them, the insured gains, because he avoids consideration of what he perceives as his true but weaker case. Assuming that the claim was in truth good all along, he will still successfully have gilded the lily (and may achieve a better settlement thereby). If the deception is revealed, either before or at trial, the insured cannot, Mr Popplewell submits, be allowed to think that he will lose nothing. The whole claim, if not the whole policy, must be forfeit, so as to introduce an incentive not to lie, paralleling that already recognised by the common law rule. Mr Popplewell would wish to subsume the use of fraudulent devices under the head of fraudulent claim. But, whether or not it is so termed, he submits that fraud in the pursuit of a claim should attract parallel treatment…There remains still open the possibility that, although categorizing a claim as fraudulent opens the way to forfeiture of the instant (and perhaps any future) claim, it does not give rise to the more drastic remedy of avoidance of the whole contract (see The Star Sea…)…Paradoxical though this might appear in relation to a type of fraud which one might think paradigmatic of want of good faith, the result could be welcome as a means of limiting the scope of the more draconian section 17… There is a dearth of convincing authority standing positively for or indeed against Mr Popplewell’s submissions. In formulating the common law rule, Mr Justice Willes in Britton v Royal Insurance Co. referred simply to “the practice to insert in fire policies conditions that they shall be void in the event of a fraudulent claim”. It is of interest that some such policy conditions deal not merely with fraud in the claim made but also “false swearing or affirming in support thereof” or the use of “any fraudulent means or devices…to obtain any benefit” under the policy: see e.g.

the clauses in Levy v Baillie (above)…What assistance, either way, is to be gained from this is less clear… The Star Sea was…concerned with alleged embellishment of the assured’s position with regard to what proved, at trial, to be a defence raised by underwriters under section 39(5) of the 1906 Act [warranty of seaworthiness of ship], on which the assured was anyway entitled to succeed. The assured was said to have withheld on discovery two experts’ reports relating to a prior casualty, because these were unhelpful to the assured in respect of underwriters’ defence. I have already pointed out that the plea of fraudulent withholding was in fact rejected. The withholding was deliberate, but the documents were privileged and the assured’s solicitors believed that there was no obligation to disclose them. I do not read Lord Hobhouse’s speech…as expressing any positive view as to the position, if the withholding had been fraudulent. What may be said to offer some general encouragement for Mr Popplewell’s submissions, is Lord Hobhouse’s general statement, at para 72, that: “Fraud has a fundamental impact upon the parties’ relationship and raises serious public policy considerations. Remediable mistakes do not have the same character.” …That some distinctions exist between fraudulent claims, in the narrow sense of cases of no or exaggerated loss, and the use of fraudulent devices is clear. 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). A fraudulent device 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. There may however be intermediate factual situations, where the lies

become so significant, that they may be viewed as changing the nature of the claim being advanced… The authorities also indicate that there are differences between, on the one hand, a fraudulent claim to recover a non-existent or exaggerated loss and, on the other, a breach of the duty of good faith under section 17. Mr Justice Rix said in Royal Boskalis [Royal Boskalis Westminster NV v Mountain [1997] LRLR 523], at p 599, that “…upon my understanding of the nature of a fraudulent claim, there is no additional test of materiality or, to put the same point perhaps in another way, the test of materiality is built into the concept of a fraudulent claim.” This observation merits some further examination. I start by noting an aspect of this Court’s decision in Galloway. The claim there made, following a burglary, for some £18,143, consisted in the main of genuine loss, but as to £2000 involved the alleged loss of a non-existent computer. The Court agreed with the Judge that the whole claim was forfeit. Lord Woolf, MR explained references in Orakpoto the need for “substantial” fraud as intended to exclude fraud which could be regarded as “immaterial” (or, in Viscount Sumner’s words in Lek v Mathews, so “unsubstantial as to be de minimis”). In this context the right approach was to look at the size of the non-existent loss alone and not to draw some comparison between it and the size of the genuine claim. Lord Justice Millett suggested that the right approach was to consider whether the making of the claim was “sufficiently serious to justify stigmatising it as a breach of [the insured’s] duty of good faith so as to avoid the policy”. This assumes that the remedy of avoidance is available in this context. Whether it is available was not in issue in either Orakpo or Galloway (as Lord Hobhouse observed in The Star Sea), and is a matter which, I suggest,

merits further examination, before the common law commits itself. Secondly, in relation to Mr Justice Rix’s observation in Royal Boskalis, to the extent that loss claimed is nonexistent, the claim will fail anyway and the fraud is clearly material in so far as it amounted to an attempt to recover for non-existent loss. But the real bite of the fraudulent claim rule is to forfeit even the genuine part of any claim; and the fraud by definition is not material in any ordinary sense to the genuine part. Thus, it is sufficient for the rule to apply that the fraud occurs in making a claim and relates to a part of the claim which, when viewed discretely, is not itself immaterial or “unsubstantial”. In contrast, it is a general requirement of section 17 that the matter fraudulently misrepresented or undisclosed should have been material. In Royal Boskalis Mr Justice Rix considered that, if the duty under section 17 extended at the claims stage to non-fraudulent, albeit culpable nondisclosure, then: “…it seems to me to make sense that the test of materiality should depend on the ultimate legal relevance to a defence under the policy of the nondisclosure or misrepresentation relied on as a breach…(p 588) and…the result would be that non-fraudulent breach of duty in relation to claim A would only be proved if the matter misrepresented or concealed justified a defence to that claim, but upon such proof the insurer would be shown to be justified, if he so chooses, to avoid the policy as a whole (p 589). In The Mercandian Continent the Court adopted Mr Justice Rix’s test (contained in these passages from Royal Boskalis) as appropriate under section 17. The Court in The Mercandian Continent was not, however, concerned with a situation where there was either a fraudulent claim or the use of any fraudulent device to promote an insurance claim. Mr Justice Rix’s test does not necessarily fit either of these situations…

What relationship need there then be between any fraud and the claim, if the fraudulent claim rule is to apply? And need the fraud have any effect on insurers’ conduct? Speaking here of a claim for a loss known to be non-existent or exaggerated, the answers seem clear. Nothing further is necessary. The application of the rule flows from the fact that a fraudulent claim of this nature has been made. Whether insurers are misled or not is in this context beside the point. The principle only arises for consideration where they have not been misled into paying or settling the claim, and its application could not sensibly depend upon proof that they were temporarily misled. The only further requirement is that the part of the claim which is nonexistent or exaggerated should not itself be immaterial or unsubstantial…That also appears consistent with general principle, even though, in a pre-contract context, no significance or sanction attaches to a fraudulent misrepresentation or non-disclosure unless it has, by misleading insurers, induced them to enter a contract… What is the position where there is use of a fraudulent device designed to promote a claim? I would see no reason for requiring proof of actual inducement here, any more than there is in the context of a fraudulent claim for nonexistent or exaggerated loss. As to any further requirement of “materiality”, if one were to adopt in this context the test identified in Royal Boskalis and The Mercandian Continent, then, as I have said, the effect is, in most cases, tantamount to saying that the use of a fraudulent device carries no sanction. It is irrelevant (unless it succeeds, which only the insured will then know). On the basis (which the cases show and I would endorse) that the policy behind the fraudulent claim rule remains as powerful today as ever, there is, in my view, force in Mr Popplewell’s submission that it either applies, or should be matched by an equivalent rule, in the case of use of a fraudulent device to promote a claim — even though at the end of a trial it may be shown that the

claim was all along in all other respects valid. The fraud must of course be directly related to and intended to promote the claim…Whenever that is so, the usual reason for the use of a fraudulent device will have been concern by the insured about prospects of success and a desire to improve them by presenting the claim on a false factual basis. If one does use in this context the language of materiality, what is material at the claims stage depends on the facts then known and the strengths and weaknesses of the case as they may then appear. It seems irrelevant to measure materiality against what may be known at some future date, after a trial. The object of a lie is to deceive. The deceit may never be discovered. The case may then be fought on a false premise, or the lie may lead to a favourable settlement before trial. Does the fact that the lie happens to be detected or unravelled before a settlement or during a trial make it immaterial at the time when it was told? In my opinion, not. Materiality should take into account the different appreciation of the prospects, which a lie is usually intended to induce on insurers’ side, and the different understanding of the facts which it is intended to induce on the part of a Judge at trial… What then is the appropriate approach for the law to adopt in relation to the use of a fraudulent device to promote a claim, which may (or may not) prove at trial to be otherwise good, but in relation to which the insured feels it expedient to tell lies to improve his prospects of a settlement or at trial?…In the present imperfect state of the law, fettered as it is by section 17, my tentative view of an acceptable solution would be: (a) To recognise that the fraudulent claim rule applies as much to the fraudulent maintenance of an initially honest claim as to a claim which the insured knows from the outset to be exaggerated, (b) To treat the use of a fraudulent device as a sub-species of making a fraudulent claim — at least as regards

forfeiture of the claim itself in relation to which the fraudulent device or means is used. (The fraudulent claim rule may have a prospective aspect in respect of future, and perhaps current, claims, but it is unnecessary to consider that aspect or its application to cases of use of fraudulent devices.) (c) 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. (d) To treat the common law rules governing the making of a fraudulent claim (including the use of fraudulent device) as falling outside the scope of section 17 (as advocated, though more generally, by Howard N Bennett [see above, [1101]]…On this basis no question of avoidance ab initio would arise…

The application of the fraudulent claim rule after litigation …For my part, I consider that it would be inappropriate to introduce a distinction between the duration of impact of the fraudulent claim rule (including in that any extension to cover the use of fraudulent devices to promote a claim) and of the section 17 duty. The present point is free from authority. The same policy considerations that led Lord Hobhouse [in The Star Sea] to restrict the latter duty to the pre-litigation period militate strongly in favour of a similar restriction of the duration of the common law duty. The present case, with its interruption of pending litigation to pick over the prior course of the litigation and to find an additional defence, provides a good example of the pragmatic objections to any continuing duty (even one

defined by reference to fraud), applying after litigation had begun. I add that similar considerations would, I believe, be borne in mind whenever the Court was called upon to construe an apparently unlimited express clause covering fraudulent claims or the use of fraudulent devices. I therefore conclude that the proposed amendments raise a case which would be obviously bad, in so far as it depends on the assertion of lying in breach of either a common law duty or a duty under section 17 continuing after the commencement of litigation. The Judge’s expression of view to that effect at p 9 in the transcript was correct, although he had by then already indicated that he would refuse the application on different grounds. For this reason, and without adopting the Judge’s primary reasoning, underwriters’ appeal should in my view be dismissed.’

Notes: 1. As Mance LJ points out in Agapitos policies frequently contain terms that specifically lay down the consequences of making a fraudulent claim. The judge also notes that such clauses may also be widely framed to encompass ‘false swearing or affirming in support thereof’ or the use of ‘any fraudulent means or devices…to obtain any benefit’ under the policy and concludes that the effect of such terms is less clear. In some USA jurisdictions the problem of distinguishing between fraudulent statements on proof of loss on the one hand, and innocent misstatement on the other, has been addressed by socalled ‘anti-technicality’ statutes whereby misrepresentations made in a proof of loss have no effect unless the insurer proves (i) that they were made fraudulently and (ii) that the insurer was misled and caused to waive or lose a valid defence to the policy: (Art 21.19 of the Texas Insurance Code).

2. Note the approach of the Insurance Ombudsman to the issue of proof where fraud is alleged:

[1106] Insurance Ombudsman Digest — Fraud ‘5. Dealing with Fraudsters …the fact is that we certainly accept that a deliberate nondisclosure for the purpose of obtaining a policy of insurance or of getting it on more favourable terms is fraudulent and we will not in such a case require any payment to be made even with a deduction. Nevertheless, it always has to be shown as a fact that the non-disclosure was deliberate, ie. fraudulent and not innocent. We do not accept the suggestion that the Bureau facilitates the commission of crime, in particular in the case of claims, by turning attempted fraud into the completed offence through requiring insurers to meet claims despite dishonesty being shown. But before we can dismiss an application on the grounds of fraud, we do need cogent evidence that that is what has been perpetrated… In our view, it is fundamental that complainants to the Bureau seeking the benefit of equitable principles should come with “clean hands”. We are wholly unwilling to help where there is sufficient evidence of fraud. Nevertheless, we are not prepared to “read between the lines”, as some insurers have put it, in order to conject or conjure a case against a policyholder. Against this, where there are good enough grounds for suspecting a fraud but the evidence does not meet the judicial standard of proof, we may well fall back on our inherent power to refuse to make a decision one way or the other. Instead we will simply conclude that the matter would be more appropriately dealt with in a court of law. Insurance Ombudsmen have no judicial powers of calling witnesses and administering oaths for the purpose of cross-

examination, nor do they enjoy any immunities and are not protected from defamation proceedings and the like to any greater extent than are insurers. This being so, insurers should not “pass the buck” to me, as it sometimes seems that they do. It would be in the best interests of insurers to investigate cases properly before allowing them to come to us. It cannot be consistent with the principles of good insurance practice for a suspect claim to be repudiated on some spurious ground which may deprive the policyholder of an opportunity to be heard on the real issue. A very frequent example of this is reliance upon lack of reasonable care or an unconnected non-disclosure where what the insurer really means is that it does not believe the loss occurred. If that reliance proves to be misplaced then we will be unable to uphold the repudiation on that ground with the result that payment might have to made to a person who has not in reality suffered any loss. We are not prepared to distort legal tests (eg. as to what constitutes reasonable care) or industry practice (eg. as to questions in proposal forms) in order to justify an insurer’ s repudiation which should have been made on grounds of fraud… Genuine claimants ought to be able to explain apparent improbabilities or discrepancies and insurer should give them an opportunity so to do. Natural justice requires no less. On the basis that we will put a policyholder’ s case to the insurer notwithstanding that he has not raised the right grounds to support it, we are prepared to adopt the same approach on behalf of the insurer and allow allegations of fraud to be fallen back on even at the eleventh hour. However, there is a fine line between seeking to arrive at an equitable result and being used, or abused, by certain insurers as an adjunct to their claims department. [AR (92) paras 6.1–6.9 p 13]…

Is fraud an issue?

In a greater number of cases…the Bureau is asked to determine the initial question of whether such fraud is established. The contribution we can make in such circumstances is limited. Where fraud is alleged by the insurer, but denied by the policyholder, it is rare that the evidence is so compelling against the policyholder that we can uphold the insurer’ s allegations without reservation. Satisfactory resolution of the issues raised in such circumstances normally requires the formal procedures of a court of law, where the relevant evidence can be given under oath and subjected to cross-examination. This is not within the scope of the Bureau’ s informal procedures. My contribution, therefore, is to consider whether the existing evidence is sufficient at least to raise the issue. If it is, then we normally feel obliged to exercise the discretion conferred on us by my Terms of Reference (para d(3)) to decline to deal with the matter. So far as the Bureau is concerned the issue is ‘non-proven’. The consequence is that the loss lies where it falls, and the insurer is not obliged to meet the claim until its liability has been established in court. It is up to the policyholder to decide whether to pursue the matter in that way.

Gut feelings/hard evidence Insurers have to accept that in deciding whether to take this relatively drastic step we cannot rely on the ‘ gut feeling’ of their Claims Managers, however reliable they may consider the sensitivities of that particular organ to be. We need something more tangible in the form of hard evidence if allegations of fraud are to be taken seriously. One colourful case concerned a substantial claim for a total of £13,000 for loss due to theft. I am afraid to say my decision may have caused the Claims Manager in question some indigestion. He regarded the claim as fraudulent, because the insurer had been told, and so had the police, that the policyholder

had been overheard in a pub planning with a third party how the theft should be perpetrated. This was a scenario which, if true, justified total repudiation of the claim and the instigation of criminal proceedings. The difficulty was that the individuals providing the information had either declined to identify themselves or had made it clear they would refuse to go on the record. Meanwhile, the policyholder was stoutly maintaining that there were people in the neighbourhood who were conducting a vendetta against him, and deliberately trying to spike his claim. This was a scenario which, if true, could have explained the shadowy accusations being made against him. We had to point out to the insurer that the police had said that they did not have enough evidence to charge the insured, and the evidence which the insurer had was not likely to stand up in court. The claim had to be met, and the insurer’ s suspicions did not justify it in taking an unreasonably harsh attitude so far as requiring the policyholder to substantiate each item of his claim was concerned. Even so, there were arguments on that score too, and we were unable to uphold the claim in full. A final assessment of £3,220 was considered appropriate, against the original claim of £13,000. This was reluctantly accepted by the policyholder.

Cards on the table Where there is sufficient evidence to cast doubt on the validity of the policyholder’ s claim, and to justify our concluding that as things stand we cannot reasonably require the insurer to meet it, we need to be satisfied that the policyholder is at least aware of what this evidence is. The insurer needs to put enough cards on the table for the policyholder to see why the outcome of the trick is in doubt. A problem can then arise, particularly in connection with disability claims, when the insurer is unwilling for us to provide policyholders with details of the evidence against

them, or even to tell policyholders of its existence, on the grounds that this may prejudice the insurer’ s case in the event of proceedings in court. Such an approach raises worrying questions of natural justice…it is clear that the basic rule must always be that either party is entitled to have particulars of the evidence against him or her on which the other party relies if we are to take it into account when making a decision. This is a requirement of natural justice, and it is also consistent with the currently accepted principle of alternative dispute resolution, that the sooner a party is in a position to realise the weight of the other side’ s evidence, the sooner he or she may be persuaded to drop unreasonable arguments and agree to a reasonable conclusion. In some cases, showing video evidence to a policyholder on Bureau premises, in the presence of an insurer’ s representative, had led to the policyholder’ s conceding that he had no claim, and thus save the insurer the possible costs of litigation to arrive at the same result. “One of my good days”, said an allegedly totally disabled policyholder at the sight of himself clambering over his roof, but it was the end of the argument. Departures from that basic rule therefore need to be clearly justified. Such justification may exist when there is an issue about the primary facts, for example if the insurer has available to it evidence which tends to show that the policyholder is either faking or grossly exaggerating the symptoms of the conditions of which he complains…To bring a case into this category: — The insurer will need to establish to our satisfaction that there are grounds for suspecting the initial good faith of the policyholder or that the revelation of the evidence would lead to the policyholder’ s trimming his or her evidence. We do not have to determine whether such suspicions are justified, only that there are reasonable grounds for them.

—

The insurer must have already indicated to the policyholder that it has such suspicions, or agree to our advising the policyholder that such suspicions exist. In other words, the insurer cannot rely on the Bureau to cover for it or to take responsibility for raising such allegations itself. — Some indication of the grounds on which such suspicions are based will also have to be given to the policyholder. Normally, when we write to the policyholder, we will identify discrepancies in his or her version of events, and explain why we do not consider the Bureau’ s informal procedures provides a satisfactory method for resolving them. — The insurer must clearly identify for us the evidence it wishes to withhold. Some indication of the nature of this evidence will normally also have to be provided to the policyholder, particularly if the insurer is relying on this evidence as part of its grounds for suspicion. By way of illustration, this was done in a recent decision in the following terms: “You ask for clarification concerning the surveillance evidence to which my Assistant referred. In addition to the medical reports the insurer’ s file includes video evidence filmed on two occasions. This evidence has also been seem by Mr X, Consultant Orthopaedic Surgeon, and it shows that your client is apparently able to carry shopping, walk at a reasonable pace, drive a car and stand unaided for prolonged periods, and undertake other physical activity around and away from the home. This is not entirely consistent with the account which your client gave to Mr X, for example, that he always needed a stick when going outdoors.” — The practice followed by some insurers of providing us with stills from video evidence to pass on to the policyholder can help to avoid any question as to the

identity of the person filmed, and can also help to indicate the nature of the activities observed. — The manner in which the policyholder is pursuing the case may also be relevant. If policyholders swear loudly at the insurer and ourselves that they will go to court if their claims are not met, it may be easier for us to tell them (politely) that we agree they should do just that. [AR (94) para 2.12 p 38]. … 7. Is the policyholder acting in good faith?

Clean hands and dirty dealing The equitable Maxim is that “he who comes into equity must come with clean hands”. From the Bureau point of view, if we have reason to doubt whether a policyholder is dealing fairly and honestly, either with the insurer or with the Bureau itself, then we decline to help…’

Note: We saw in chapter 4 that the ABI has sought to mitigate the consequences of non-disclosure in favour of consumer-insureds. The ABI’s Statements of Practice also address the issue of claims. [1107] Statements of General Insurance Practice (London, Association of British Insurers, 1986) (replacing 1977) ‘…2. Claims (a) Under the conditions regarding notification of a claim, the policyholder shall not be asked to do more than report a claim and subsequent developments as soon as reasonably possible except in the case of legal

processes and claims which a third party requires the policyholder to notify within a fixed time where immediate advice may be required. (b) An insurer will not repudiate liability to indemnify a policyholder: (i) on grounds of non-disclosure of a material fact which a policyholder could not reasonably be expected to have disclosed; (ii) on grounds of misrepresentation unless it is a deliberate or negligent misrepresentation of a material fact; (iii) on grounds of a breach of warranty or condition where the circumstances of the loss are unconnected with the breach unless fraud is involved. Paragraph 2(b) above does not apply to Marine and Aviation policies. (c) Liability under the policy having been established and the amount payable by the insurer agreed, payment will be made without avoidable delay.’

[1108] Statements of Long Term Insurance Practice (London, Association of British Insurers, 1986) ‘…3. Claims (a) An insurer will not unreasonably reject a claim. In particular. an insurer will not reject a claim or invalidate a policy on grounds of non-disclosure or misrepresentation of a fact unless: (i) it is material fact; and (ii) it is a fact within the knowledge of the proposer; and (iii) it is a fact which the proposer could reasonably be expected to disclose. (It should be noted that

(b)

(c)

(d)

(e)

fraud or deception will, and reckless or negligent nondisclosure or misrepresentation of a material fact may, constitute grounds for rejection of a claim.) Except where fraud is involved, an insurer will not reject a claim or invalidate a policy on grounds of a breach of a warranty unless the circumstances of the claim are connected with the breach and unless: (i) the warranty relates to a statement of fact concerning the life to be assured under a life of another policy and that statement would have constituted grounds for rejection of a claim by the insurer under 3 (a) above if it had been made by the life to be assured under an own life policy; or (ii) the warranty was created in relation to specific matters material to the risk and it was drawn to the proposer’s attention at or before the making of the contract. Under any conditions regarding a time limit for notification of a claim, the claimant will not be asked to do more than report a claim and subsequent developments as soon as reasonably possible. Payment of claims will be made without avoidable delay once the insured event has been proved and the entitlement of the claimant to receive payment has been established. When the payment of a claim is delayed more than two months, the insurer will pay interest on the cash sum due, or make an equivalent adjustment to the sum, unless the amount of such interest would be trivial. The two month period will run from the date of the happening of the insured event (that is, death or maturity) or, in the case of a unit linked policy, from the date on which the unit linking ceased, if later. Interest will be calculated at a relevant market rate

from the end of the two month period until the actual date of payment. (f) In the case of a tax exempt policy with a friendly society; the total of the cash sum due and such interest to the date of the claim cannot exceed the statutory limit on such assurance…’

[1109] Association of British Insurers, General Insurance Claims Code ‘What this code does This code sets out the standards of service you can expect when you make a claim. It applies if you, as a private individual, make a claim on a general insurance policy that was issued by an insurance company which is a member of the Association of British Insurers. For example, this includes claims on household, motor, travel, payment protection and private medical insurance policies. You can make claims in different ways. This code covers the following types of claims: — Claims you make on insurance policies you have taken out, for example, your own motor or household policy. — Claims on group policies, for example, a private medical insurance policy a company has taken out for its employees. — Claims you make against someone else which are dealt with under an insurance policy they have taken out, for example, a motor accident caused by another driver. These types of claims are very different from each other. They are often processed and settled in different ways, which are all covered by the code, so some parts of the code may not apply to your claim. If you are claiming against someone else and their insurance company, the company should tell you that they

need the other person to agree to the company handling your claim. They should also tell you that if the other person does not agree to the company handling your claim, you may need to take legal action against the other person and you want to go further. You should be aware that for some claims, especially if you are injured and claim against someone else, the law and the courts set different requirements which insurance companies must follow. The insurance company you claim against will explain this to you. General principles At all stages, you can expect that insurance companies will: — respond promptly, explain how they will handle your claim and tell you what you need to do; — give you reasonable guidance to help you make a claim under the policy; — consider and handle your claim fairly and promptly and tell you how your claim is progressing; — tell you if they cannot deal with all or any part of your claim, and explain why; — settle your claim promptly, once they have agreed to do so; and — handle complaints fairly and promptly. When you first make a claim You can expect: — a response, on the phone or in writing, to your claim, and action within five working days; — an explanation of whether your type of claim is normally covered by the policy, — an explanation of what should happen and when; — and if you are claiming against someone else’s insurance company, to be told, within 10 working days, what information and evidence they need to consider your claim.

Processing your claim You can expect: — replies to your letters within 10 working days; — explanations of why other people (for example, loss adjusters, solicitors, surveyors, doctors or consultants) will be involved in your claim and what their role will be; and — your insurance company to contact any other insurance company that is involved in your claim within 10 working days of finding out who they are. Settling your claim You can expect: — an explanation of how your type of claim is usually settled, for example: — by paying you; — by paying someone else, such as the garage repairing your car, your loan or mortgage company or your doctor if your claim is on a private medical insurance policy; or — by repairing or replacing something; — payments to be made to you within 10 working days of you agreeing to it; — the insurance company to arrange repairs to, or a replacement of, whatever was damaged, within 10 working days of you agreeing to it; and — an explanation of why the amount the insurance company offers, or plans to pay, is different from the amount you claimed, or why your claim has been rejected. … All insurance companies that follow this code belong to independent disputes settlement organisations which provide a free service for policyholders who are private individuals.’

Notes:

1. See also the GISC General Insurance Code for Private Customers and the GISC Commercial Code in chapter 3 ([303] and [304]). 2. In Agapitos (above) Mance LJ called for legislative intervention to clarify once and for all the scope and inter-relationship between the doctrine of good faith and section 17 of the 1906 Act in relation to the claims process. A suitable template for any such statutory provision may be found in the Australian legislation: [1110] Section 56 of the (Australian) Insurance Contracts Act 1984 (Cth) (as Amended) ‘Part VI: Claims FRAUDULENT CLAIMS 56 (1) Where a claim under a contract of insurance, or a claim made under this Act against an insurer by a person who is not the insured under a contract of insurance, is made fraudulently, the insurer may not avoid the contract but may refuse payment of the claim. (2) In any proceedings in relation to such a claim, the court may, if only a minimal or insignificant part of the claim is made fraudulently and non-payment of the remainder of the claim would be harsh and unfair, order the insurer to pay, in relation to the claim, such amount (if any) as is just and equitable in the circumstances. (3) In exercising the power conferred by subsection (2), the court shall have regard to the need to defer fraudulent conduct in relation to insurance but may also have regard to any other relevant matter.’

11.2 Negligent and Wilful Conduct 11.2.1 (i) Claims and the Insured’s Negligence The fact that the loss was proximately caused (see chapter 10) by the insured’s negligent act does not, by itself, preclude recovery. Covering such losses is often one of the aims of the insurance, as, for instance, is the case with the third party liability insurance. Indeed, a term in such a policy that requires the insured to take reasonable care will be construed so as not to undermine the purpose of the policy and were it to be interpreted as meaning the insurers would not be liable if the insured failed to take reasonable care — in other words, where the insured is negligent — then the policy would have no point because the insured is only liable to a third party whom he or she injures through negligence (Tinline v White Cross Insurance Association Ltd [1921] 3 KB 327, 330, per Bailhache J, see [1114]). Similarly, first party property typically covers losses caused by the negligence of the insured (Harris v Poland [1941] 1 KB 462, see [907]). Nevertheless, insurers do have a legitimate interest in putting terms into a policy that impose a duty on the insured to act with caution. See, JE Adams, ‘Reasonable Care Provisions, the Courts and the Ombudsman’ [1998] JBL 85; J Birds, ‘Reasonableness Conditions in Insurance Contracts’ (1991) 1 Insur L & P 18; V

Cowen, ‘Lack of Reasonable Care Conditions’ (1993) 3 Insur L & P 4. [1111] Fraser v B N Furman (Productions), Ltd [1967] 2 Lloyd’s Rep 1 (CA) [An employee’s injuries were caused by the employer’s failure to provide a guard on a machine as required by the Factories Act. The employer claimed under an employer’s liability policy for reimbursement of the damages payable to the employee. Among the issues before the court was that the effect of a policy term: ‘The Insured shall take reasonable precautions to prevent accidents and disease’]. Diplock LJ: ‘The first point to consider is the question of construction of that condition. It must be construed, of course, in the context of a policy of insurance against specified risks. The risks so specified, which are ‘liability at law for damages’, are liability for breach of statutory duty for which the owner or occupier of the factory would always be personally liable, negligence at common law of the employer, for which he would be personally liable, and also the negligence of his servants, for which he would be vicariously liable. Therefore, when one approaches the construction of the condition, one does so in this context, and applies the rule that one does not construe a condition as repugnant to the commercial purpose of the contract. There are three considerations to be borne in mind on the wording of this condition. (1) It is the insured personally who must take reasonable precautions. Failure by an employee to do so, although the employer might be liable vicariously

for the employee’s negligence or breach of statutory duty, would not be a breach of the condition. That was established in, and was the ratio decidendi of, the case of Woolfall and Rimmer Ltd v Moyle and Another [1942] 1 KB 66. (2) The obligation of the employer is to take precautions to prevent accidents. This means, in my view, to take measures to avert dangers which are likely to cause bodily injury to employees. (3) The third word to be construed in this context is “reasonable”. “The Insured shall take reasonable precautions to prevent accidents”. “Reasonable” does not mean reasonable as between the employer and the employee. It means reasonable as between the insured and the insurer having regard to the commercial purpose of the contract, which is inter alia to indemnify the insured against liability for his (the insured’s) personal negligence. That, too, is established by the case that I have cited. Obviously the condition cannot mean that the insured must take measures to avert dangers which he does not himself foresee, although the hypothetical reasonably careful employer would have foreseen them. That would be repugnant to the commercial purpose of the contract, for failure to foresee dangers is one of the commonest grounds of liability in negligence. What in my view is “reasonable” as between the insured and the insurer, without being repugnant to the commercial object of the contract, is that the insured should not deliberately court a danger, the existence of which he recognises, by refraining from taking any measures to avert it. Equally the condition cannot mean that where the insured recognises that there is a danger, the measures which he takes to avert it must be such as the hypothetical reasonable employer, exercising due care and observing all the relevant provisions of the Factories Act, 1961, would have taken. That, too, would be repugnant to the commercial purpose of the contract, for failure to take such measures is another ground of liability in negligence for breach of statutory duty. What in my judgment is

reasonable as between the insured and the insurer, without being repugnant to the commercial purpose of the contract, is that the insured, where he does recognise a danger, should not deliberately court it by taking measures which he himself knows are inadequate to avert it. In other words, it is not enough that the employer’s omission to take any particular precautions to avoid accidents should be negligent; it must be at least reckless, that is to say, made with actual recognition by the insured himself that a danger exists, not caring whether or not it is averted. The purpose of the condition is to ensure that the insured will not refrain from taking precautions which he knows ought to be taken because he is covered against loss by the policy. On that construction of the condition, which seems to me to be implicit though not expressly stated in some obiter dicta of Lord Justice Goddard (as he then was) in Woolfall and Rimmer Ltd v Moyle and Another, sup., I next turn to the facts of this case. Miss Fraser was injured when a welding machine, which operated like an ordinary press, came down on her hand. The machine had originally been provided by the manufacturers with two buttons. The operator needed both hands to press these to put the press in motion, thus providing a precaution against the danger of the operator putting his or her hand into the press when it was moving. Some time in 1961, about 18 months before the accident, the machine had been changed, and changed to the design of the manager of the factory (which was a small one) with the knowledge and assistance of the managing director, the employers being in effect a one-man company. As a result of this change, the buttons which had hitherto operated as a precaution against danger to the operator were removed, and a table was placed in front of the machine which removed the operator farther from the working parts. Miss Fraser, as I say, caught her hand in the machine.

The learned Judge found, not unnaturally, that there was a breach of duty under Sect. 14 of the Factories Act, 1961, in that this was a dangerous part of machinery, and was not securely fenced. He said (and this has been really the basis of the argument for the appellants): “The Plaintiff’s case is put first of all on the basis that there was a breach here of section 14 of the Factories Act. There plainly was. It was as manifest a breach as I have ever seen in any case of this kind in all my experience, at the Bar or on the Bench. This was, I think, plainly a dangerous part of the machinery. It was not merely a moving part, not merely a part in which a person’s hand could be trapped — could easily be trapped — but it was also a part which had in it very high heat so that if a hand was trapped the most appalling injuries would be caused. If ever there was a machine which called to high heaven for fencing it was this machine, and there simply was not any sort or kind of fence at all.” The Judge then goes on to deal with the negligence of the employer in altering this machine off his own bat, and he goes on to say this: “…If a very carefully designed machine is altered and the result of the alteration is to produce a danger which the original design had been quite carefully worked out so as to minimise, it seems to me that that prima facie must be judged as a failure on the part of the employers to take proper care for the safety of their work people, thus subjecting them to quite unnecessary risk and they are probably not even appreciating the sort of risk they are subjecting their employees to.” The learned Judge thus found common-law negligence, but it is significant, in the light of the construction which I have

placed upon Condition 4, that he says that probably they did not even appreciate the kind of risk that was involved in the change which they made in the machine. He also found common-law negligence on the part of the managing director in failing to give sufficient instructions to Miss Fraser as to how to avoid the danger. Mr Hirst has argued (and I think I would accept that he has established this point) that both the breach of statutory duty and the negligence, having regard to the personal part that the managing director played in the adaptation of the machine, was a breach for which the employers, a limited company, were personally liable, and not merely vicariously liable. What he goes on to say is that, because the learned Judge stigmatised it in the words which I have already read as a very bad breach, the liability of the insurance company under the policy would have been excluded by Condition 4. As I have already indicated, on my view as to the true construction of that condition, it would have been necessary, in order to succeed, for the third party to show affirmatively that the failure to take precautions, or that the particular measure taken in altering this machine, was done recklessly, that is to say, with actual recognition of the danger to employees which was entailed, and not caring whether or not that danger was averted. The learned Judge found nothing of the sort. Indeed, in the passage that I have read he has made plain his view that on the balance of probabilities the managing director and none of the staff appreciated the danger which was involved.’

Note: 1. It was held in Sofi v Prudential Assurance Co Ltd [1993] 2 Lloyd’s Rep 559 that the insurers were liable on a policy covering property against theft when jewellery worth £42, 035 was stolen from the locked glove compartment of a locked car

which had been left in a car park for fifteen minutes, even though a term of the policy required the insured to take reasonable care. The Court of Appeal stated that the recklessness test was not confined to liability policies, but also applied to property insurance. Lloyd LJ: ‘Mr Wadsworth argued that it was reckless of the plaintiff not to take the jewellery with him when he climbed the mound or not to have left somebody behind in the car, having regard to the value of the jewellery. I do not accept that submission. If the plaintiff had given no thought at all to the jewellery the submission might have succeeded; or if, to take another example, the plaintiff had left the jewellery exposed to view. But here the plaintiff and his son-inlaw considered together what was best to do. They were not going to be absent from the car for more than half an hour at the most. In the event they were absent for much less than half an hour. They decided that in the circumstances the safest thing to do was to leave the jewellery in the locked glove compartment. I cannot regard that decision as having been taken recklessly.’ Prior to Sofi, the Insurance Ombudsman Bureau had taken a view more favourable to insurers by ruling that whether reasonable care had been taken depended on the value of the goods, the reason for them being in the place from which they were stolen, the precautions taken to prevent theft and the alternative courses of action open to the insured (see Annual Report, London, IOB, 1985). The Sofi decision led to the following comment from the Insurance Ombudsman Bureau:

‘It is well to remember that the Sofi case was significant because it applied to property insurance an approach which had already been held by the courts to apply to liability insurance. Effectively, Sofi was saying nothing new in terms of what constitutes “reasonable care”. Given its ordinary meaning lack of “reasonable care” could mean simple negligence. However, the courts have consistently held that a provision that a policyholder would not be covered if he were negligent would be contrary to the commercial purpose of the policy and so the words “reasonable care” cannot be taken at face value. The breach requires something much more than mere negligence. It is also worth remembering that there is no implied term or “common law duty” requiring a policyholder to take reasonable care. If there is anything, it must be a contractual term and the burden of proving breach is on the insurer. Negligence may not amount to breach of such a condition but recklessness does…In brief…the legal position is that the insured who is to deprive himself of benefit under his policy through “lack of reasonable care” or the like must “court” a danger the existence of which he recognises. He courts danger by taking measures which he knows are inadequate to avert it or indeed no measures at all. Recognition of the risk is subjective as is knowledge of the adequacy (or lack) of the steps taken to avert that risk. The fact that others might have taken different steps or that the policyholder himself would with the benefit of hindsight is irrelevant. The policyholder does not have to satisfy any basic test of reasonable prudence in order to make a successful claim. The test is recklessness. There must also, of course, be a casual connection between the recklessness and the loss…Indeed, there are very few instances in which the Courts themselves actually have found against a policyholder and in those cases where

they have there has been extreme or blatant or gross negligence which has obviously amounted to recklessness. …By way of comfort to insurers, we can only emphasise that there are a number of factors which we can and do properly take into consideration in assessing whether or not a policyholder should be treated as having been reckless. One of them is the value of the property: the greater the value, the greater the risk and the easier it will be for an insurer to establish it was deliberately courted — in particular valuable property should not be left temptingly exposed to view. Other factors are the length of time that the property has been left and the vulnerability of the place in which it is left. The issue of a safer alternative can only be relevant if what might have been done is so obvious and comparatively so safe and easy that by failing to do it the policyholder must be taken to have deliberately courted the risk.’ (Annual Report 1993), cited in P Hart, ed, Digest of Annual Reports and Bulletins, 2nd edn, (London, IOB, 1999)

2. In Cooke v Routledge [1998] NI 174 (CA, Northern Ireland), Cooke wrote off his car when driving while heavily intoxicated and his insurers repudiated liability on the ground that he had failed to take reasonable care ‘to safeguard the vehicle from loss or damage’, as required by the terms of the policy. The court held the insurers liable because the crash had not been a deliberate act by Cooke, nor was it the inevitable or the natural and probable consequence of his action. Moreover, the term was not meant to apply to these circumstances since safeguarding

the car meant protecting it from an external threat not driving it carefully. 3. In Gunns v Par Insurance Brokers [1997] 1 Lloyd’s Rep 173, the insurers were not held liable after the theft of jewellery owned by Mr Gunns. The policy required him to take all reasonable precautions to avoid loss. It was shown that he failed to activate the burglar alarm or lock the back door of the property, in spite of his belief that he was being followed and his knowledge that the insurers did not regard the safe in which the jewellery was kept as secure. 4. A particular area of difficulty has been clauses that exclude liability for the theft of a car where the key is left in the ignition. The Financial Ombudsman Service (successor to the Insurance Ombudsman Bureau) has taken the view that they will find for the insured where the driver was ‘sufficiently close to the car to be able to intervene and had not “left” the car’ (Financial Ombudsman Service, Annual Review of 1 April 2001 to 31 March 2002 (London, 2002). This followed the decision in Hayward v Norwich Union Insurance Ltd [2001] 1 All ER (Comm) 545 (CA), where the policy expressly excluded, ‘Loss of damage arising from theft whilst the ignition keys of your car have been left in or on the car’ and required the insured to ‘take reasonable steps to safeguard your car from loss or damage.’ The car was fitted with an immobiliser, as required by the insurers. The owner, who had been led to believe that the immobiliser was the primary protection

device, went to pay for petrol at a kiosk some 15– 25 yards from the car, leaving the keys in the ignition. The car was stolen. The Court of Appeal held that the insurers were not liable because Mr Hayward had breached a clearly worded term of the policy and had moved too far away from the car to make prevention of theft likely. (On the position of the Insurance Ombudsman Bureau prior to the Hayward decision, see the report for 1997 in P Hart, ed, Digest of Annual Reports and Bulletins, 2nd edn, (London, IOB, 1999)). 5. The position in Australia is confused with regard to the application of Diplock’s principles to a policy condition that requires the insured to comply with all statutory regulations. According to Professor Kenneth Sutton (“Recent Developments in Insurance Law”, paper delivered to the New South Wales Insurance Law Association, Sept 2002, www.aila.com.au/research): ‘If there is no provision limiting the assured’s obligation to the exercise of reasonable care to observe the requirement, the condition is strictly construed, although the result is to limit severely the extent of the cover provided by the policy. Where the limiting qualification is contained in the condition, the Full Court of South Australia has applied the principle in Fraser v Furman (Productions) Ltd, extending it, by analogy, to the compliance provision; while the New South Wales Court of Appeal has distinguished the taking of reasonable precautions to prevent personal injury or damage to property (which attracts the Fraser v Furman (Productions) Ltd principle) from the taking of

such precautions to comply with statutory obligations or regulations relating to the safety of persons or property. Apparently, the commercial purpose of the policy is not offended by giving effect to the latter condition of the policy where there has been a negligent failure to observe safety regulations. It is submitted that the Fraser principle should be applied to both qualified and unqualified compliance conditions so as to exclude inadvertent or negligent failure to comply with statutory obligations etc and thus afford the typical assured with the protection that he or she thinks has been obtained.’

11.2.2 (ii) Claims and the Wilful Act of the Insured Policies are often designed to cover losses caused by wilful actions, so, for instance, a theft policy covers loss caused by the deliberate action of a third party. Furthermore, a deliberate act of the insured, which played a role in the loss, may not preclude the insurers’ liability if that act was reasonable in the circumstances and the insured peril was operating, as when the ventilators in a cargo hold were closed to prevent the entry of sea-water during a heavy storm and this caused the cargo to overheat (Canada Rice Mills Ltd v Union Marine and General Insurance Co [1941] AC 55 (PC). See, Sir Michael J Mustill, ‘Fault and Marine Losses’ [1988] LMCLQ 310). Insurers will not be liable where the insured would benefit from their own criminal act (ex turpi causa non oritur actio), even if the insured did not realize the act was

criminal (Haseldine v Hosken [1933] 1 KB 822). Furthermore, ‘The insurer is not liable for any loss attributable to the wilful misconduct of the assured’ (Marine Insurance Act 1906, section 55(2)(a)), and the use of the word ‘attributable’ rather than ‘proximate’, which appears in section 55(1) (see [103]), indicates that the loss need not be promixately caused by the wilful misconduct. In Amicable Insurance Society v Bolland (1830) 4 Bligh NS 194, those entitled to the assets of Henry Fauntleroy, who was hanged in 1824 for forgery, were unable to claim on a life policy taken out nine years before, even though it could hardly be supposed that his intention in committing the forgery was to be detected and hanged. Yet, not all criminal acts trigger these rules and certainly that act must be connected to the loss. Moreover, as Lord Esher ([1112]) states, alongside the principle that an insured should not benefit from their criminal act, is the consideration that the insurers should not too readily be relieved of their liability. [1112] Cleaver v Mutual Reserve Fund Life Association [1892] 1 Q B 147 (CA) Lord Esher MR: ‘No doubt there is a rule that, if a contract be made contrary to public policy, or if the performance of a contract would be contrary to public policy, performance cannot be enforced either at law or in equity; but when people vouch that rule to excuse themselves from the performance of a contract, in respect of which they have received the full consideration,

and when all that remains to be done under the contract is for them to pay money, the application of the rule ought to be narrowly watched, and ought not to be carried a step further than the protection of the public requires.’

[1113] Beresford v Royal Insurance Co Ltd [1938] AC 586 (HL) [In 1925 Major Rowlandson took out policies on his own life with the Royal Insurance for £50,000. In 1934 Rowlandson was insolvent following an unsuccessful attempt to develop a process for hardening steel. He owed large amounts of money and could not afford the premiums on the life policies as they fell due. He obtained extensions of the time for payment, but a few minutes before the expiration of the last of these extensions he shot himself. The House of Lords held that the estate of Rowlandson could not claim the benefit under the policy]. Lord Atkin: ‘In discussing the important subject of the effect of suicide on policies of life insurance it is necessary to distinguish between two different questions that are apt to be confused: (1) What was the contract made by the parties? (2) How is that contract affected by public policy? (1) On the first question, if there is no express reference to suicide in the policy, two results follow. In the first place intentional suicide by a man of sound mind, which I will call sane suicide, ignoring the important question of the test of sanity, will prevent the representatives of the assured from recovering. On ordinary principles of insurance law an assured cannot by his own deliberate act cause the event upon which the insurance money is

payable. The insurers have not agreed to pay on that happening. The fire assured cannot recover if he intentionally burns down his house, nor the marine assured if he scuttles his ship, nor the life assured if he deliberately ends his own life. This is not the result of public policy, but of the correct construction of the contract. In the second place this doctrine obviously does not apply to insane suicide, if one premises that the insanity in question prevents the act from being in law the act of the assured. On the other hand, the contract may and often does expressly deal with the event of suicide: and that whether sane or insane. It may provide that death arising at any time from suicide of either class is not covered by the policy. It may make the same stipulation in respect of suicide of either or both classes happening within a limited time from the inception of the policy. The rights given to the parties by the contract must be ascertained according to the ordinary rules of construction: and it is only after such ascertainment that the question of public policy arises. In the present case the contract contained in the policy provided that the company would pay the sum assured to the person or persons to whom the same is payable upon proof of the happening of the event on which the sum assured was to become payable. It further provided that the policy was subject to the conditions and privileges endorsed so far as applicable. It contained the further stipulation that unless it was otherwise provided in the schedule the policy, subject to the endorsed conditions, was indisputable. The schedule specified the assured as Charles Rowlandson, the life assured as the assured, the event on the happening of which the sum was to become payable as the death of the life assured, and the person or persons to whom the sum was payable as the executors, administrators or assigns of the assured.

The only relevant condition is condition 4, which reads as follows: “If the life or any one of the lives assured (being also the assured or one of them) shall die by his own hand, whether sane or insane, within one year from the commencement of the assurance, the policy shall be void as against any person claiming the amount hereby assured or any part thereof, except that it shall remain in force to the extent to which a bona fide interest for pecuniary consideration, or as a security for money, possessed or acquired by a third party before the date of such death, shall be established to the satisfaction of the Directors.” My Lords, I entertain no doubt that on the true construction of this contract the insurance company have agreed with the assured to pay to his executors or assigns on his death the sum assured if he dies by his own hand whether sane or insane after the expiration of one year from the commencement of the assurance. The express protection limited to one year, and the clause as to the policy being indisputable subject to that limited exception seem to make this conclusion inevitable. The respondents’ counsel appeared shocked that it should be considered that a reputable company could have intended to make such a contract: but the meaning is clear: and one may assume from what one knows of tariff conditions that it is a usual clause. There is no doubt therefore that on the proper construction of this contract the insurance company promised Major Rowlandson that if he in full possession of his senses intentionally killed himself they would pay his executors or assigns the sum assured. (2) The contract between the parties has thus been ascertained. There now arises the question whether such a contract is enforceable in a court of law. In my opinion it is not enforceable. The principle is stated in the judgment of Fry LJ in Cleaver v Mutual Reserve Fund

Life Association [1892] 1 QB 147, 156: “It appears to me that no system of jurisprudence can with reason include amongst the rights which it enforces rights directly resulting to the person asserting them from the crime of that person.” The cases establishing this doctrine have been fully discussed by Lord Wright MR in his judgment in the present case. I mention some of them in order to call attention to the fact that, while in the earlier cases different reasons have been given for the rule, the principle can now be expressed in very general terms. In Fauntleroy’s case, Amicable Insurance Society v Bolland (1830) 4 Bligh NS 194, 211…“Is it not void upon the plainest principles of public policy? Would not such a contract (if available) take away one of those restraints operating on the minds of men against the commission of crimes, namely, the interest we have in the welfare and prosperity of our connexions?”…In this case the ground given is the removal of a restraint against the commission of crime. In Moore v Woolsey 4 E & B 243 the Court of Queen’s Bench refused to hold void a condition that a policy on the life of a person who should die by his own hands would remain in force to the extent of any bona fide interest acquired as security for money. The assured had died by his own hand, but whether sane or insane did not appear. Lord Campbell, in deciding for the plaintiff, said that a stipulation that if a man committed suicide within a year the policy should give a right of action would be void. He appears to put it on the ground that it would offer an encouragement to suicide. In Cleaver’s case [1892] 1 QB 147 the executors of James Maybrick were suing on a life policy which he had effected in favour of his wife, who had been convicted of his murder. The objection that the executors were suing to enforce a trust in favour of the wife was got over by holding that the wife could get no benefit from her crime, but that, her interest failing, the

executors could recover for the benefit of the testator’s estate. It should be noticed that on the principle stated it is not a question of refusing to enforce a contract made by the criminal: the doctrine avoids a testamentary gift: and it would appear to be immaterial whether the criminal knows or not of the intended gift. If he does not know, the inducement to commit the crime and the removal of the restraint against committing the crime both tend to disappear as supports for the doctrine. In Crippen’s case [1911] P 108, the question arose as to whether administration of the estate of a deceased wife who had been murdered by her husband should be granted to the next of kin of the wife passing over the legal personal representative of the husband. The President, Sir Samuel Evans, decided in favour of the wife’s next of kin and said [at 112]: “It is clear that the law is, that no person can obtain, or enforce, any rights resulting to him from his own crime; neither can his representative, claiming under him, obtain or enforce any such rights. The human mind revolts at the very idea that any other doctrine could be possible in our system of jurisprudence.” Finally, in Hall v Knight and Baxter [1914] P 1, the Court decided that a woman who had killed a testator in circumstances that amounted to manslaughter, but not, it would appear, manslaughter by negligence, could not be allowed to claim probate as a legatee under the will of the testator. Swinfen Eady LJ said [at 8]: “The estate of the testator must go in the same way as if there were no benefit given to Jean Baxter by the will and that she cannot in any way benefit from the crime which she has committed. I see no reason for restricting the rule to cases of murder.” Lord Sumner, then Hamilton LJ, said [at 7]: “The principle can only be expressed in that wide form. It is that a man shall not slay his benefactor and thereby take his bounty.” It may be remarked that this

pithy statement, while applicable to the case under discussion, is not as wide as the principle permits. It would not be apt to decide a claim under a contract where the criminal may have given full consideration, and could hardly be said to be “taking bounty from a benefactor.” I think that the principle is that a man is not to be allowed to have recourse to a Court of Justice to claim a benefit from his crime whether under a contract or a gift. No doubt the rule pays regard to the fact that to hold otherwise would in some cases offer an inducement to crime or remove a restraint to crime, and that its effect is to act as a deterrent to crime. But apart from these considerations the absolute rule is that the Courts will not recognize a benefit accruing to a criminal from his crime. The application of this principle to the present case is not difficult. Deliberate suicide, felo de se, is and always has been regarded in English law as a crime, though by the very nature of it the offender escapes personal punishment…The suicide is a felon…By English law a survivor who had agreed with him to commit suicide with him is guilty of murder: and the attempt to commit suicide is an attempt to commit a felony and punishable accordingly: Rex v Mann (1914) 10 Cr App R 31. The remaining question is whether the principle applies where the criminal is dead and his personal representative is seeking to recover a benefit which only takes shape after his death. It must be remembered that the money becomes due, if at all, under an agreement made by the deceased during his life for the express purpose of benefiting his estate after his death. During his life he had power of complete testamentary disposition over it. I cannot think the principle of public policy to be so narrow as not to include the increase of the criminal’s estate amongst the benefits which he is deprived of by his crime. His executor or administrator

claims as his representative, and, as his representative, falls under the same ban. Anxiety is naturally aroused by the thought that this principle may be invoked so as to destroy the security given to lenders and others by policies of life insurance which are in daily use for that purpose. The question does not directly arise, and I do not think that anything said in this case can be authoritative. But I consider myself free to say that I cannot see that there is any objection to an assignee for value before the suicide enforcing a policy which contains an express promise to pay upon sane suicide, at any rate so far as the payment is to extend to the actual interest of the assignee. It is plain that a lender may himself insure the life of the borrower against sane suicide; and the assignee of the policy is in a similar position so far as public policy is concerned. I have little doubt that after this decision the life companies will frame a clause which is unobjectionable: and they will have the support of the decision of the Court of Queen’s Bench in Moore v Woolsey, where a clause protecting bona fide interests was upheld. It was suggested to us that so far as the doctrine was applied to contracts it would have the effect of making the whole contract illegal. I think that the simple answer is that this is a contract to pay on an event which may happen from many causes, one only of which involves a crime by the assured. The cause is severable and the contract, apart from the criminal cause, is perfectly valid…’

Notes: 1. Changes in the law on suicide (Suicide Act 1961) may affect the view taken in Beresford: see the comments of Salmon LJ in Gray v Barr [1971] 2

QB 554 at 582 [1116], Farquharson LJ in Kirkham v Chief Constable of Greater Manchester Police [1990] 2 QB 283 at 295-6, and of the Court of Appeal in Dunbar v Plant [1997] 3 WLR 1261. 2. In Northwestern Mutual Life Insurance Co v Johnson 254 US 96 (US Supreme Court, 1920), which Lord Atkin cited but refused to follow, the US Supreme Court held that, although a term not allowing a claim in the event of suicide would be implied into a life policy, where a policy expressly referred to suicide, by, for instance, providing for payment of benefit on suicide after the expiration of a certain period (as in Beresford), there was no general principle to prevent payment and it was a matter for individual states to decide to legislate or not. [1114] Tinline v White Cross Insurance Association Ltd [1921] 3 KB 327 [A speeding motorist, who killed one pedestrian and injured two others as they crossed Shaftesbury Avenue in London, was convicted of manslaughter involving gross or reckless negligence. The issue in this case was whether the insurers were liable on personal accident policy]. Bailhache J: ‘The policy sued on indemnifies the assured against sums which he shall become legally liable to pay to any other person as compensation for “accidental personal injury.” A

man does not become liable to pay compensation for accidental personal injury unless the accident is due to his negligence. The policy therefore is one which insures against the consequences of negligence, including personal negligence. The defendants say however that where the negligence is so gross and excessive that as a result of it a man is killed and the crime of manslaughter is committed the assured cannot claim an indemnity, for it is said it is against public policy to indemnify a person against the civil consequences of his criminal act… The fact that one of the three persons was killed is, as I have said, really immaterial for the purposes of this case; it was the incident of the accident, or the accident of the accident, an accident due, it is true, to gross negligence, but the policy is an insurance against negligence whether slight or great, and it seems to me that it covers this case. It must of course be clearly understood that if this occurrence had been due to an intentional act on the part of the plaintiff, the policy would not protect him. If a man driving a motorcar at an excessive speed intentionally runs into and kills a man, the result is not manslaughter but murder. Manslaughter is the result of an accident and murder is not, and it is against accident and accident only that this policy insures.’

[1115] Hardy v Motor Insurers’ Bureau [1964] 2 QB 745 (CA) [Vincent Phillips was convicted of maliciously inflicting grievous bodily harm and fined after he drove off at speed dragging along Mr Hardy, a security officer, who had tried to speak to him as he left the premises on which Hardy worked. Phillips was uninsured and Hardy succeeded against the Motor Insurers’ Bureau, which was established to meet

claims for injury or death to third parties caused by uninsured or untraceable drivers out of funds supplied by the insurance industry. The MIB undertook to pay any award, ‘if judgment in respect of any liability which is required to be covered by a policy of insurance…under…the Road Traffic Act…is obtained…and any such judgment is not satisfied.’ The MIB would, therefore, be liable if an insurer of Phillips would have been liable under that Act.] Diplock LJ: ‘The injuries which the plaintiff sustained were caused by or arose out of Phillips’ use of his motor van on a road. Phillips’ liability to the plaintiff falls within the ordinary meaning of the very simple words used in the statute [Road Traffic Act, 1960, s 203(3)(a)]. Why should some other meaning be ascribed to them?…[W]hat is there in the context, the subject-matter or the disclosed policy of Part VI of the Road Traffic Act, 1960, which compels the conclusion that, notwithstanding that the liability which Phillips incurred to the plaintiff falls within the ordinary meaning of the words of section 203 which I have quoted, those words are nevertheless to be understood as excluding it? The argument, as I understand it, comprises two parts, the first based on a rule of law: the second on a canon of statutory construction. Part I: (a) All contracts to indemnify a person against a liability which he may incur by committing an intentional crime are unlawful. (b) Phillips’ liability to the plaintiff was incurred by his committing an intentional crime. (c) Therefore any contract insuring Phillips against the liability which he incurred to the plaintiff would have been an unlawful contract. Part II: (a) Parliament cannot have intended by sections 201 and 203 of the Road Traffic Act, 1960, to compel a

person to enter into an unlawful contract. (b) Therefore the general words of section 203 must be read as excluding any obligation to insure against liability incurred by committing an intentional crime. (c) Therefore Phillips was not required by section 203 to be insured against the liability which he incurred to the plaintiff. The whole of this argument depends on the correctness of the major premise of the syllogism in Part I of this argument. In my view it is a false premise, if by an unlawful contract is meant a contract which is incapable of giving rise to any right on the part of any person to enforce its terms by action in the courts. The rule of law on which the major premise is based — ex turpi causa non oritur actio — is concerned not specifically with the lawfulness of contracts but generally with the enforcement of rights by the courts, whether or not such rights arise under contract. All that the rule means is that the courts will not enforce a right which would otherwise be enforceable if the right arises out of an act committed by the person asserting the right (or by someone who is regarded in law as his successor) which is regarded by the court as sufficiently anti-social to justify the court’s refusing to enforce that right. From this, which in my view is the correct formulation of the rule, two consequences follow: (1) The court’s refusal to assert the right is exercisable only against the person (including anyone who is regarded in law as the successor of that person, such as a personal representative or trustee in bankruptcy) who has committed the anti-social act out of which the right would, in the absence of the rule, arise: it is not exercisable against any other person in whom the right arising out of the contract is vested. Thus in Cleaver v Mutual Reserve Fund Life Association the contract of insurance on the life of Mr Maybrick was enforceable by his executors although the right arising out of the statutory trust in favour of his murderer, Mrs Maybrick, under section 11 of the Married Women’s Property Act, 1882, was

unenforceable, and since enforceability is the badge of a trust, the court held that the statutory trust had come to an end. (2) The court’s refusal to assert a right, even against the person who has committed the anti-social act, will depend not only on the nature of the anti-social act but also on the nature of the right asserted. The court has to weigh the gravity of the anti-social act and the extent to which it will be encouraged by enforcing the right sought to be asserted against the social harm which will be caused if the right is not enforced. Thus, although before the Law Reform (Married Women and Tortfeasors) Act, 1935, the court refused to enforce any right of contribution between joint tortfeasors even where the joint tort was negligence, the rights of the assured under contracts of insurance against loss caused by his own negligence were enforced at the suit of the assured notwithstanding that the negligence was criminal: Tinline v White Cross Insurance [[1921] 3 KB 327]; James v British General Insurance Co [[1927] 2 KB 311]. How, then, does the rule affect a contract of insurance to pay a sum of money, whether by way of indemnity or otherwise, on the occurrence of an event which may or may not be caused by the anti-social act of the assured? First, the rule has no effect on the construction of the contract. It deals with enforceability of rights arising out of the contract. One first construes the contract to see what the parties agreed: see Beresford v Royal Insurance Co. The rule does not alter that. Secondly, the contract so construed is not unlawful. It is capable of giving rise to legally enforceable rights if, apart from the rule, the rights of the assured are capable of becoming vested in a third party other than one who is regarded in law as the successor of the assured, such as the personal representative (Beresford v Royal Insurance Co) or his trustee in bankruptcy (Amicable Insurance Society v Bolland [(1830) 4 Bligh NS 194]). I agree, with respect, with Lord Atkin’s opinion expressed in Beresford’s case that an assignee for value before the occurrence of the event

would not be prevented from enforcing the contract notwithstanding that the event was caused by the antisocial act of the original assured. At common law the benefit of a contract of insurance indemnifying the assured against his liability to third parties is incapable of assignment, for an assignee would have no insurable interest in the subject-matter of the insurance. The scheme of Part VI of the Road Traffic Act, 1960, is not to effect a statutory assignment of the assured’s rights under his contract of insurance but to confer on a third party, who suffers bodily injury as a result of the tortious act of the assured and obtains judgment against him, a direct right of action against the insurers. The judgment which gives rise to the direct liability of the insurers to the third party under section 207 must be a judgment in respect of a liability of the assured covered by the terms of the contract of insurance which the assured is required by sections 201 and 203 to enter into with the insurers. The words in section 203, which I have cited, thus control not only the terms of the contract to be entered into between the assured and the insurers but also the statutory rights of the third party against the insurers. This being so, I can see no ground for construing them otherwise than in their natural meaning. To do so does not offend against the rule ex turpi causa non oritur actio. It does not exclude its operation on the enforceability of any rights of the assured under the contract so construed or on the statutory rights of the third party. No doubt in the unlikely event of the assured himself discharging his liability to the third party, the rule ex turpi causa non oritur actio would prevent his enforcing his contractual right to indemnity against the insurers if the event which gave rise to his liability to the third party were an intentional crime committed by the assured. But the rule would not prevent a third party from enforcing his statutory rights against the insurers, for he did not commit the antisocial act. He was its victim. The purpose of the rule is to

prevent persons becoming victims, not to penalise them when it has failed in its purpose. Is there, then, anything in the disclosed policy of Part VI of the Road Traffic Act, 1960, apart from the general rule, which I have discussed, to compel the conclusion that the general words of section 203, which define (inter alia) the statutory rights of injured third parties against insurers, were intended to be understood in some sense narrower than their ordinary meaning. Everything seems to me to point the other way. The whole purpose of this Part of the Act is for the protection of the persons who sustain injury caused by the wrongful acts of other persons who use vehicles on a road, and it was no part of the policy of the Act that the assured’s rights to enforce his own contract against the insurers should constitute the sole measure of the third party’s rights against the insurers, as section 205 shows. The liability of the assured, and thus the rights of the third party against the insurers, can only arise out of some wrongful (tortious) act of the assured. I can see no reason in public policy for drawing a distinction between one kind of wrongful act, of which a third party is the innocent victim, and another kind of wrongful act; between wrongful acts which are crimes on the part of the perpetrator and wrongful acts which are not crimes, or between wrongful acts which are crimes of carelessness and wrongful acts which are intentional crimes. It seems to me to be slightly unrealistic to suggest that a person who is not deterred by the risk of a possible sentence of life imprisonment from using a vehicle with intent to commit grievous bodily harm would be deterred by the fear that his civil liability to his victim would not be discharged by his insurers. I do not myself feel that by dismissing this appeal we shall add significantly to the statistics of crime…’

Notes:

1. In Gardner v Moore [1984] AC 549, the House of Lords expressly approved of the decision in Hardy and, in the only speech delivered, Lord Hailsham LC quoted extensively from the judgment of Diplock LJ. 2. Charlton v Fisher [2002] QB 578 (CA) illustrates the position where the Road Traffic Act does not apply. Jean Charlton was injured when Sheridan Fisher deliberately reversed his car into hers in a hotel car park. He did not intend to injure Charlton, but he was convicted of criminal damage. If the incident had happened on a public road, the insurers would have been liable to Charlton irrespective of the terms of the policy, but since it happened on private land the Road Traffic Act did not apply. The Court of Appeal held that Fisher had used the car in a way not covered by the policy, which only referred to ‘accidents’ and not deliberate criminal acts that result in injury. So, although Fisher had not intended to injure, he could not obtain advantage from an act that had been deliberately undertaken. Moreover, Charlton was the statutory assignee of the insured under the Third Parties (Rights against Insurers) Act 1930 (see Part 11.4 below) and so stood in his shoes, which meant that, since Fisher had no claim, nor did Charlton. [1116] Gray v Barr, Prudential Assurance Co Ltd (Third Party) [1971] 2 QB 554 (CA)

[Mr Barr, believing that his wife had restarted a love affair with a neighbour, Mr Gray, burst into Gray’s house waving a shotgun. Barr fired into the ceiling to frighten Gray, who was standing on the stairs, and then tried to force past him. A struggle ensued. Barr fell backwards with the result that, involuntarily, he fired the gun a second time. Gray was shot and killed. Barr was acquitted of both murder and manslaughter. He was sued by Gray’s wife. The Court of Appeal held that Barr’s insurers were not liable under a ‘hearth and home’ policy indemnifying him if damages were awarded against him for bodily injury ‘caused by accidents’.] Lord Denning, MR: ‘1. Was the death of Mr Gray caused by accident? Although the jury in the criminal trial found Mr Barr not guilty (presumably because they thought it might have been an accident), nevertheless it is, I think, open to the insurance company to go behind that verdict and prove that the shooting of Mr Gray was not an accident, but a deliberate act on the part of Mr Barr… Was this bodily injury caused by accident? That is the question. The facts of this case are so, unusual that there is very little guidance to be got from the authorities. The word, “accidents” in this policy clearly includes injury which is caused by the negligence or fault of Mrs Barr or her husband or some member of her household: for it is only for such accidents that there is any “legal” liability. It is to cover “legal” liabilities the insurance is given. But the word “accidents” does not include injury which is caused deliberately or intentionally. If a man shoots another in selfdefence, or under gross provocation, the death is not

caused by accident. It is caused by a deliberate act, no matter how justifiable or excusable it may be. But, if a man shoots another whilst out shooting pheasants, without intention, being grossly negligent, the death is caused by accident, even though it be manslaughter. In the present case we have two acts to consider. The one deliberate. The other accidental. (1) There was first this deliberate act by Mr Barr. He went into the farmhouse with a loaded shotgun, intending to frighten Mr Gray by firing it. That was no accident. He went upstairs with the loaded gun. He fired the first shot through the ceiling. That was no accident. (2) Then there was this second act: the two men grappled together, and, in the course of it, Mr Barr fell. The gun went off and killed Mr Gray, That was an accident in this sense, that it was not deliberate. But which of these acts was the cause of the death? Was it the deliberate act of Mr Barr approaching Mr Gray with a loaded gun? Or was it the fall and subsequent discharge of the gun? The immediate cause was the second act when the gun was accidentally discharged, but the dominant cause was the first act when Mr Barr went up the stairs with a loaded gun determined to see into the bedroom. Which of these causes is the relevant cause for the purpose of the policy?…Ever since [Leyland Shipping Co Ltd v Norwich Union Fire Insurance Society Ltd [1918] AC 350]…in 1918 it has been settled in insurance law that the “cause” is that which is the effective or dominant cause of the occurrence, or, as it is sometimes put, what is in substance the cause, even though it is more remote in point of time, such cause to be determined by common sense… Applying this principle I am of opinion that the dominant and effective cause of the death was Mr Barr’s deliberate act in going up the stairs with a loaded gun determined to see into the bedroom. The whole tragic sequence flows inexorably from that act. It was because of that loaded approach that Mr Gray grappled with Mr Barr. It was

because of the grappling that Mr Barr fell and the gun went off. There was no new intervening cause at all. Each one of us would readily forgive Mr Barr. He was distraught, fearful, anxious, provoked beyond endurance, quite beside himself with the thought that his wife had gone back to this man once again. Yet his conduct in walking up the stairs with the loaded gun was no accident. It was deliberate. He was determined to get into the bedroom to see if his wife was there. It was the dominant cause of the death. It is not covered by the wording of the policy of insurance.

2. Is the claim barred by public policy? In case I am wrong about this, I turn to the next question. Is it against public policy to allow Mr Barr to, recover on the insurance? There is no doubt, to my mind, that Mr Barr was guilty of manslaughter. I know that at the criminal trial he was acquitted altogether. But that was a merciful verdict: and in this civil action we must, when called upon, give the true decision according to law. During the argument we had much discussion on the issue of manslaughter, such as “motor manslaughter” when a high degree of negligence is said to suffice: see Andrews v Director of Public Prosecutions [1937] AC 576; and “weapon manslaughter” when an unlawful and dangerous act has been said to be enough: see Rex v Larkin [1943] KB 174; 29 Cr App R 18. But I do not think it necessary to go into the matter at length. I would only say this: In manslaughter of every kind there must be a guilty mind. Without it, the accused must be acquitted: see Reg v Lamb [1967] 2 QB 981. In the category of manslaughter relating to an unlawful act, the accused must do a dangerous act with the intention of frightening “or harming” someone, or with the realisation that it is likely to frighten or harm someone, and nevertheless he goes on and does it, regardless of the consequences. If his act does

thereafter, in unbroken sequence, cause the death of another, he is guilty of manslaughter. Thus a seaman, Larkin, brandished an open razor so as to frighten his woman’s lover, but in the ensuing dialogue he cut the woman’s throat. According to him it was an accident because she swayed against him when the razor was in his hand. The judge directed the jury that, even accepting his own evidence, it was manslaughter: and they could not in law find him not guilty. The Court of Criminal Appeal upheld this direction: see Rex v Larkin 29 Cr App R 18. Next Reg v Cashmore (unreported), 28 July 1959; post, p 572. Sapper Cashmore took a rifle from the armoury, loaded it with live rounds, and went about with it, holding people up, intending to rob them. His officer tried to get him to put the rifle down. In the course of it all, the rifle went off and the officer fell dead. According to Cashmore it was an accident The Court of Criminal Appeal held that, even if the gun did go off accidentally, “he is still guilty of manslaughter, and there is no escape from it.…No court martial, properly directed, could reach any conclusion but that this was manslaughter at the very least.”…The present case is exactly in line with those two. Mr Barr took this loaded gun intending to frighten Mr Gray. Mr Gray told him to put it down. He did not do so but advanced with it, determined to get into the bedroom to see if his wife was there. According to Mr Barr, the fatal shot was an accident, but it flowed. in unbroken. sequence from his initial dangerous act, and is beyond doubt manslaughter. Does this manslaughter mean that, as matter of public policy, Mr Barr is not to be allowed to recover on the policy? In the category of manslaughter which is called “motor manslaughter,” it is settled beyond question that the insured is entitled to recover: see Tinline v White Cross Insurance Association Ltd [1921] 3 KB 327; James v British General Insurance Co Ltd [1927] 2 KB 311. But, in the category which is here in question, it is different. If his conduct is wilful and culpable, he is not entitled to recover:

see Hardy v Motor Insurers’ Bureau [1964] 2 QB 745. I agree with the judge when he said [1970] 2 QB 626, 640: “The logical test, in my judgment, is whether the person seeking the indemnity was guilty of deliberate, intentional and unlawful violence, or threats of violence. If he was, and death resulted therefrom, then, however unintended the final death of the victim may have been, the court should not entertain the claim for indemnity.” The judge cited for this proposition In the Estate of Hall [1914] P 1…Applying this proposition, the judge held that Mr Barr was not entitled to indemnity from the Prudential. I agree with him. In my opinion, therefore, Mr Barr cannot recover, on the policy. It was not an accident, and also he is defeated by public policy. It will be noticed by the observant that the two questions raise one and the same point of causation. If the death of Mr Gray was caused by the deliberate act of W. Barr in going up the stairs with a loaded gun, it was no accident, and it would, in any case, be against public policy to allow him to recover indemnity for the consequences of it.’

Salmon LJ: ‘This appeal raises three questions of law. 1. Were the injuries which resulted in the death of the late James Gray caused by accident? 2. If so, was this an accident of a kind which fell within the terms of a policy of insurance dated 12 October 1966, covering the assured against “all…sums which [he should] become legally liable to pay as damages in respect of a bodily injury to any person…caused by accidents…?” 3. If the answer to both these questions is Yes, is George Barr (admitted to be the assured) prevented by principles of public policy from enforcing the contract of insurance?

1. Were the injuries resulting in James Gray’s death caused by accident? In my view Barr’s acquittal at the Old Bailey both of murder and manslaughter cannot affect his rights against the Prudential or their liability to him under the insurance policy. Notwithstanding the acquittal, the Prudential could have alleged as part of their defence that the killing was intentional and therefore outside the policy. Very properly they elected not to do so. They admitted that Barr did not intend to kill Gray or to do him grievous bodily harm; nor did they allege that Barr intended to injure Gray. They did, however, allege that the killing amounted to manslaughter. I do not understand how, in the circumstances, such an allegation can march hand-in-hand with a contention that the killing was not caused by accident. Whether it was the kind of accident covered by the policy is another matter, with which I shall presently deal. Except in cases in which murder is reduced to manslaughter on the ground of provocation or diminished responsibility, manslaughter is necessarily an accidental killing. Otherwise it would be murder. The injury leading to death by manslaughter may, however, be no accident; sometimes it may be intentionally caused, for example where a man punches another and fells him to the ground so that he fractures his skull and dies, or a man intentionally sticks a pin into someone who happens to be a haemophiliac, and he bleeds to death. Similarly, in murder, a killing may sometimes, in a sense, be accidental; for example, when a man inflicts serious injuries with intent only to do grievous bodily harm and death ensues. In such a case the injuries are caused intentionally and not by accident. Only the consequences of the injuries are accidental. Accordingly in neither of the types of manslaughter or murder postulated would the offender be covered by this policy of insurance since it applies only to liability for injuries caused by accident.

“Accident” — and for that matter, “caused” is an imprecise word and its meaning sometimes is susceptible to much metaphysical discussion. I agree however with the judge that injury caused by accident can, qua the man causing the injury, only mean injury caused without negligence or without intention to injure. If one thing in this case is clear it seems to me to be that the word “accident,” as used in the policy of insurance, cannot possibly mean an act done without negligence. An assured cannot be legally liable for any injury caused by accident unless he has inflicted the injury by negligence. That, obviously is the very risk against which he intends to insure. Accordingly if “accident” does not include an act done negligently, the policy of insurance would make no sense. It is only fair to say that, as I understood the argument, counsel for the Prudential did not contend for such a restricted meaning of the word. And I am not at all surprised. Were we to hold that “accident” did not apply to negligent acts, I imagine that the lucrative class of insurance business covered by the “hearth and home” policy would disappear overnight. Such policies are taken out only by people who wish for protection against liability for injuries caused by accidents due to their own negligence or that of members of their family. I cannot agree that the judge looked at the second shot “in vacuo.” In my view he rightly considered it in the light of all that led up to it. He contrasted it with the first shot which was intentionally fired — albeit to frighten but not to injure. I agree with the judge that “accident” connotes “without intending to injure.” I also agree that however negligent or reckless Barr may have been and however deliberate and dangerous his actions leading up to the shooting, still on the assumption, which is conceded, that he did not intend to shoot or injure Gray, the injuries from which Gray died were caused by accident. Prior to the Road Traffic Acts 1930–1934 which compelled a driver to be insured against liability for

all third party risks — even for intentionally running down a pedestrian — it had never been suggested that a motorist who injured a person whilst driving had not caused the injury by accident because he was deliberately driving at a speed he realised to be dangerous and in a way which might well kill or injure members of the public — not even if he was drunk and knew it: see, for example, Tinline v White Cross Insurance Association Ltd [1921] 3 KB 327; James v British General Insurance Co Ltd [1927] 2 KB 311. These cases were decided on the basis that the injuries had been caused by accident which rendered the insurers liable under the terms of the policy and the only point discussed was whether, on grounds of public policy, the assured was precluded from enforcing his contractual rights. I recognise that “it is now established…that causa proxima in insurance law does not necessarily mean the cause last in time but what is ‘in substance’ the cause…or the cause to be determined by ‘common-sense principles: Canada Rice Mills Ltd v Union Marine and General Insurance Co Ltd [1941] AC 55, 71, per Lord Wright.” …This does not mean, however, that the last cause necessarily can never be the real cause of any loss or injury. I should think that it would be difficult to hold, at any rate on principles of common sense, that a ship which sank after being torpedoed or scuttled with the intention of sending her to the bottom of the sea had been lost fortuitously. The cause of the loss in such a case was obviously no accident and cannot be attributed to perils of the sea. Since Barr is conceded to have had no intention of shooting or injuring Gray. I find it equally difficult to hold that the shot which went off unintentionally was fired or caused Gray’s injuries and death otherwise than by accident. I am afraid that I cannot agree that the judge

approached this case on the old-fashioned basis that the last of many causes leading up to the accident was necessarily the real cause of the accident: see lonides v Universal Marine Insurance Co 14 CBNS 259, 289. I think that he decided (rightly in my view) that the accident of Barr falling on the gun and thereby firing the second barrel was in substance and in common sense the real cause of Gray’s injuries resulting in his death. For these reasons I agree with the judge’s finding that the injuries to Gray were caused by accident. 2. Was this accident an accident of a kind intended to be covered by the policy of insurance? This is a difficult question. I incline to the view that, although the accident in question was of the genus “accident” referred to in the policy, it was not a species of that genus which the policy was intended to cover. No doubt, the language of the policy is wide enough to cover any kind of accident. I think, however, that it should be read as subject to an implied exception. The exception being that the policy does not apply to injuries caused by an accident occurring in the course of threatening unlawful violence with a loaded gun. It is, of course, well settled that no term can be implied into a contract unless necessary to give it ordinary business efficacy. I doubt whether from the point of view of ordinary business the parties can be taken to have intended to cover such a risk as this unless at any rate they had stated such an intention in express words. Put in another way, if the officious bystander had asked the parties when the policy was written, “Do you intend to cover such an accident as this?” they would have both unhesitatingly answered “No.” If I am right in this view, no question of public policy can arise. If, however, I am wrong and the contract does cover accidents of this kind, then the question arises:

3. Is the defendant precluded on grounds of public policy from enforcing the contract of insurance? It is well settled that if a man commits murder or committed felo de se in the days when suicide was still a crime, neither he nor his personal representatives could be entitled to reap any financial benefit from such an act: In the Estate of Crippen [1911] P 108; Beresford v Royal Insurance Co Ltd [1938] AC 586. This was because the law recognised that, in the public interest, such acts should be deterred and moreover that it would shock the public conscience if a man could use the courts to enforce a money claim either under a contract or a will by reason of his having committed such acts. Crimes of violence, particularly when committed with loaded guns, are amongst the worst curses of this age. It is very much in the public interest that they should be deterred. A man, covered by a “hearth and home” policy such as the present, walks into a bank with a loaded gun. He intends only to frighten and not to shoot the cashier. He slips and accidentally shoots a customer standing by the counter. It would be strange indeed if he could enforce the policy in respect of his liability to that customer. Once you threaten violence with a loaded gun and it goes off it is so easy to plead accident. Evidently it is very difficult for the prosecution to prove the contrary. Although public policy is rightly regarded as an unruly steed which should be cautiously ridden, I am confident that public policy undoubtedly requires that no one who threatens unlawful violence with a loaded gun should be allowed to enforce a claim for indemnity against any liability he may incur as a result of having so acted. I do not intend to lay down any wider proposition. In particular, I am not deciding that a man who has committed manslaughter would, in any circumstances, be prevented from enforcing a contract of indemnity in respect of any liability he may have incurred for causing death or from inheriting under a will or upon the

intestacy of anyone whom he has killed. Manslaughter is a crime which varies infinitely in its seriousness. It may come very near to murder or amount to little more than inadvertence, although in the latter class of case the jury only rarely convicts. Hall’s case [1914] P 1 may seem to be an authority for the proposition that anyone who has committed manslaughter, in any circumstances, is necessarily under the same disability as if he had committed murder. The facts however are not stated in the report and they are of vital importance in order to understand the decision. They have now been ascertained from the record. A man named Julian Hall kept a woman named Jeannie Baxter and had made a will in her favour. They had had many quarrels. He had promised to marry her but had not done so. On 13 April 1913, she took his revolver and, whilst he was in bed, shot him dead with four or five shots. She was acquitted of murder but convicted of manslaughter. It is small wonder that the court held that, on grounds of public policy, she could not take under Hall’s will. The only surprising thing about the case is that she was acquitted of murder, apparently for no reason — except, perhaps, that she was defended by Mr Marshall Hall. The cases of Tinline [1921] 3 KB 327 and James [1927] 2 KB 311, in which it was held that persons convicted of manslaughter for reckless and drunken driving could nevertheless recover indemnity from their insurers, were doubted in Haseldine v Hosken [1933] 1 KB 822 but approved by this court in Marles v Philip Trant & Sons Ltd [1954] 1 QB 29. It seems now to be settled law that a motorist can rely on his policy of insurance to indemnify him in respect of his liability for any injuries which he has caused otherwise than on purpose: Hardy v Motor Insurers’ Bureau [1964] 2 QB 745. These road traffic cases may be sui generis. In any event, although motor cars have sometimes been called lethal weapons, these cases are not in my view akin to the cases in which injuries are, caused in the course

of unlawfully threatening a man with a loaded gun. Public policy is not static. Even if the crime of suicide had not been abolished by statute, it may be that today Beresford’s case [1938] AC 586 would have been differently decided. In any event, threatening violence with a loaded gun would, I am sure, now be generally regarded as much more shocking and necessary to be deterred than what the unfortunate Major Rowlandson did in Beresford’s case. I am confident that, in any civilised society, public policy requires that anyone who inflicts injuries in the course of such an act shall not be allowed to use the courts of justice for the purpose of enforcing any contract of indemnity in respect of his liability in damages for causing injury by accident.’

Phillimore, LJ: ‘I confess that I find these arguments too specious and too clever I do not think that you can isolate the second shot from all that went before. In my judgment the incident should be regarded as a whole… Was the fact that the shot so fired actually killing Gray an accident in the true sense? Could Barr have said it was an accident if it had merely wounded Gray or if it had killed somebody else who happened to be nearby? No doubt the word “accident” involves something fortuitous or unexpected, but the mere fact that a wilful and culpable act which is both reckless and unlawful has a result which the actor did not intend surely does not, if that result was one which he ought reasonably to have anticipated, entitle him to say that it was an accident. After all, an unlawful and reckless act may result in death albeit the actor did not intend to cause that death if he had it would, of course, have been murder. If he did not is it. automatically an accident? If anyone who saw him doing it could foresee that it was dangerous and reckless and might result in harm to another and in the event it did so and thus

caused a death which the law terms manslaughter, does the ordinary citizen term it an accident? I think not. I am conscious of cases where the unlawful act was so technical or the recklessness so unlikely to cause death that if death resulted an ordinary citizen might say: “Well, the lawyers can call it manslaughter but I call it an accident.” This case is not in that sort of class. This was a grave case of violence to the person-an unlawful act in that it was an assault in circumstances calculated to cause terror-it was reckless in that it was carried out with a loaded gun which if it was discharged as it might well be in the course of the violent episode created by the actor might well cause death. I find some support for this view in MacGillivray on Insurance Law, 5th edn (1961), Vol 2, p 790, para 1645: “Where the happening which caused the death or injury was the foreseeable result of an intended action of the insured, the death or injury is not caused by accident.” He then goes on to quote instances. I would also refer to Lord Atkin’s speech in Beresford v Royal Insurance Co Ltd [1938] AC 586, 595: “On ordinary principles of insurance law an assured cannot by his own deliberate act cause the event upon which the insurance money is payable. The insurers have not agreed to pay on that happening. The fire assured cannot recover if he intentionally bums down his house, nor the marine assured if he scuttles his ship, nor the life assured if he deliberately ends his own life. This is not the result of public policy, but of the correct construction of the contract.” …Who can suppose that either party, if told the facts of this case when entering into the contract, would have agreed

that the death of Gray could be regarded as an “accident” covered by the policy? In my judgment then this was not an accident and accordingly the policy cannot avail Barr in his defence. In any case, however, I am satisfied that on the facts of this case the judge was right in finding that the defendant Barr was precluded by public policy from recouping himself from the Prudential against the claim of the plaintiff. As Lord Denning MR and Salmon LJ have said manslaughter varies from conduct which is almost murder to conduct which is only criminal in the technical sense. It would be foolish to attempt to lay down any general rule. It is wiser I think to confine decision to the facts in this case. In an age of violence — age where the use of firearms is all too frequent-it would I think be very odd if a man who had had in his hands a loaded shotgun from which a shot had been fired and had killed another at a time when he had just assaulted that other with the gun could recover on an insurance policy which protected him from liability if he was negligent in the use of the shotgun. This was in fact a grave case of manslaughter and in my judgment the judge was right in saying that the defendant could not recover against the Prudential on the grounds of public policy.’

Notes: 1. The courts have adopted Geoffrey Lane J’s test from Gray v Barr [1970] 2 QB 626, 640, cited by Lord Denning MR, that the rule should apply where death results from ‘deliberate, intentional and unlawful violence’, even if the death of the victim was unintended or accidental. 2. Gray v Barr has been widely supported by the judiciary, including the Supreme Court of

Canada: see RA Hasson, “The Supreme Court of Canada and the Law of Insurance 1975” (1976) 14 Osgoode Hall Law Journal 769 at 776–8; J Lowry and P Rawlings, Insurance Law: Doctrines and Principles (Oxford, Hart, 1999), pp 162–7; and Oldfield v Transamerica Life Insurance Co of Canada [1118]. The case, like Charlton v Fisher [2002] QB 578 (CA) (above), raises a number of problems. The first is that it ignores the shift in the twentieth century from a focus on the insured to a focus on the victim in the context of certain types of liability insurance (see Part 11.3). However, Gray does not involve compulsory liability insurance and Mrs Barr is no worse off than if Mr Gray had not had insurance. Leaving that aside, Diplock LJ in Hardy argued that to refuse the claim of the victim in that case in order to deter crime would be unrealistic, particularly in view of the fact that the risk of life imprisonment had failed to achieve that goal. The people likely to suffer most are those who are denied damages if the insurers are not held liable. On the other hand, Shand (J Shand, ‘Unblinkering the Unruly Horse: Public Policy in the Law of Contract’ (1972) 30 CLJ 144) has suggested that, ‘deterrence has become a firmly established factor in the application of public policy to contract law’ (at 155). In Oldfield [1118], L’Heureux-Dubé J quoted from RB Wuehler, “Rethinking Insurance’s Public Policy Exclusion: California’s Befuddled Attempt to Apply an Undefined Rule

and a Call for Reform” (2001) 49 UCLA L Rev 651, 654: ‘Certainly there is some merit to the position that wrongdoers should not be indemnified by insurance carriers, but instead should be punished for their wrongdoing. On the other hand, however, every time coverage is precluded pursuant to this theory, an innocent victim is left uncompensated for his or her suffering and an otherwise enforceable contractual obligation is extinguished without consideration. As these two interests collide, the dispositive question that surfaces is, what level of misconduct constitutes a significant enough violation of public policy to render an insurance agreement void because it overcomes the competing public policy considerations that favor extending coverage?’

(See also W Gelhorn, ‘Contracts and Public Policy’ (1935) 35 Col LR 679). Finally, that the victim suffers loss is not a reason for making the insurers liable and, of course, if the insurers are required to pay that will fall on the policyholders generally through an increase in premiums. [1117] Dunbar v Plant [1998] Ch 412 (CA) Mummery LJ: ‘It is sufficient that a serious crime has been committed deliberately and intentionally. The references to acts or threats of violence in the cases are explicable by the facts of those cases. But in none of those cases were the courts legislating a principle couched in specific statutory language. The essence of the principle of public policy is that (a) no person shall take a benefit resulting from a crime

committed by him or her resulting in the death of the victim and (b) the nature of the crime determines the application of the principle. On that view the important point is that the crime that had fatal consequences was committed with a guilty mind (deliberately and intentionally). The particular means used to commit the crime (whether violent or nonviolent) are not a necessary ingredient of the rule. There may be cases in which violence has been used deliberately without an intention to bring about the unlawful fatal consequences. Those cases will attract the application of the forfeiture rule. It does not follow, however, that when death has been brought about by a deliberate and intentional, but non-violent, act (e.g. poison or gas) the rule is inapplicable.’

Notes: 1. Dunbar v Plant involved the application of the forfeiture rule, which precludes those who have unlawfully killed from acquiring a benefit as a consequence of that act. It was held that the rule applied to the survivor of a suicide pact as well as to someone convicted of murder or manslaughter. The Forfeiture Act 1982 allows a court, in cases other than murder, to modify the forfeiture rule. In determining whether to apply its discretion under the Act, the court will first determine whether the rule applies and then consider matters such as the offender’s moral culpability, the financial position of the offender and, particularly in spouse manslaughter, the treatment of the offender by the deceased.

2. If someone is precluded by the forfeiture rule from benefiting under a policy on the victim’s life, then, although that person is unable to claim, the policy is not rendered void. Where a wife was convicted of murdering her husband, the court ordered her claim under a life policy to be ignored and this meant that under its terms the proceeds fell into the husband’s estate: Cleaver v Mutual Reserve Fund Life Association [1892] 1 QB 147. [1118] Oldfield v Transamerica Life Insurance Co of Canada 210 DLR (4th) 1 (Supreme Court of Canada, 2002) [When Paul and Maria Oldfield separated, they agreed Paul would maintain sufficient life insurance coverage instead of providing child and spousal support and Maria would be named as the beneficiary of that policy. Paul Oldfield died accidentally in Bolivia while smuggling cocaine. He had swallowed 30 cocaine-filled condoms and one burst causing a heart attack. The insurers argued that Mrs Oldfield’s claim was barred by the public policy principle that a person should not be allowed to insure against his own criminal act. It was agreed that ingesting cocaine was contrary to Bolivian and Canadian law. The court held the insurers were liable]. Major J: [with whom McLachlin CJC, Gonthier, Iacobucci, Bastarache, Binnie, Arbour and Lebel JJ concurred]

‘II. ANALYSIS There are two issues in this appeal: 1. Is there a public policy rule that renders a life insurance contract unenforceable where the insured dies accidentally as a result of his or her own crime, regardless of who the beneficiary is? 2. If there is such a public policy rule, is the rule inapplicable because the insurance contract was obtained pursuant to a bona fide contract for value?

A. The Public Policy Rule (1) Generally The public policy rule at issue is that a criminal should not be permitted to profit from crime. Unless modified by statute, public policy operates independently of the rules of contract. For example, courts will not permit a husband who kills his spouse to obtain her life insurance proceeds, regardless of the manner in which the life insurance contract was worded. As Ferguson J held in the court below, public policy “applies regardless of the policy wording — it is imposed because of the courts’ view of social values” (p 119). Generally, though, an insurer seeks the shelter of public policy rules because they have failed to specifically provide for the contingency that gives rise to the dispute. In the present appeal, the insurance policy did not provide for the result that would occur if the insured died while committing a criminal act. If the policy specifically excluded coverage, there would be no need to resort to public policy. The public policy rule that prevents criminals from profiting from crime has existed for many years…[citing Cleaver and Beresford] Canadian courts have recognized the public policy rule…In Brissette Estate v Westbury Life Insurance Co, [1992] 3 SCR 87, 96 DLR (4th) 609, Sopinka J held that “a person should not be allowed to insure against

his or her own criminal act irrespective of the ultimate payee of the proceeds” (p 94). The rule extends to those who claim through the criminal’s estate. In Cleaver, Fry LJ held that “the rule of public policy should be applied so as to exclude from benefit the criminal and all claiming under her” (p 159 (emphasis added)). Technically, the reason why no distinction is drawn between the criminal and his or her estate is that the estate’s claim is equivalent to a claim brought by the criminal. In Beresford v Royal Insurance Co [1937] 2 All ER 243 (CA), Lord Wright MR explained (at p 249): “…the plaintiff, as personal representative, stands in the shoes of the assured…[T]he present claim is equivalent technically to a claim brought by a murderer, or his representative or assigns, on a policy effected by the murderer on the life of the murdered man. In that latter case, it is, we think, clear that neither the murderer nor his estate nor his assigns could take a benefit under the policy.” However, innocent beneficiaries are neither criminals nor claim through the criminal’s estate. Because of that, the public policy rule is inapplicable. Section 195 of Ontario’s Insurance Act, RSO 1990, c 1.8, states that “[a] beneficiary may enforce for the beneficiary’s own benefit…the payment of insurance money made payable to him, her or it in the contract…”. In Kerslake v Gray [1957] SCR 516, 8 DLR (2d) 705, the Court held that insurance money paid to an ordinary beneficiary does not form part of the insured’s estate. In Borins JA’s words, Maria Oldfield “has not asserted her right to the insurance proceeds as a successor of the insured, but as an ordinary beneficiary, with the result that her claim is not tainted by any illegality on the part of her husband” (p 748) [para 29]. The distinction between a claim by a beneficiary as opposed to a claim through the estate developed in

decisions like Hardy v Motor Insurers’ Bureau [1964] 2 QB 745 (CA), where Lord Diplock held (at p 768): “[The insurance contract] is capable of giving rise to legally enforceable rights if, apart from the [public policy] rule, the rights of the assured are capable of becoming vested in a third party other than one who is regarded in law as the successor of the assured…” In Cleaver, Fry LJ held (at p 159): “…I think that the rule of public policy should be applied so as to exclude from benefit the criminal and all claiming under her, but not so as to exclude alternative or independent rights.” A distinction between the criminal’s estate and innocent beneficiaries was adopted in Stats v Mutual of Omaha Insurance Co (1976) 14 OR (2d) 233, 73 DLR (3d) 324 (CA), affirmed on other grounds [1978] 2 SCR 1153, 87 DLR (3d) 169. In that case, an insured named her sister the beneficiary of an accident insurance policy. The insured became grossly intoxicated, drove her car into a building, and was killed. The insured’s sister sought to obtain the benefits of the insurance policy…The Ontario Court of Appeal…ordered the insurance company to pay the proceeds to the innocent beneficiary, concluding (at p 243): “Since the insured personally or indirectly through her estate did not and could not benefit from her crime, it follows that the general rule of public policy would not be infringed by paying to the appellant beneficiary the proceeds to which she is entitled under the policy.” Borins JA concluded Stats was applicable to Maria Oldfield’s claim in this case. He held (at p 749):

“In my view, the circumstances of this case come within the decision in Stats where this court held that where a crime is committed by the insured, and the insured did not intend to cause her death through the commission of the crime, the beneficiary named in a policy insuring against accidental death, not being the estate of the insured, was not precluded from taking the insurance proceeds because the rule of public policy did not apply.” I agree with Borins JA’s analysis. …In Brissette, above, Sopinka J held that it is consistent with public policy “that a person should not be allowed to insure against his or her own criminal act irrespective of the ultimate payee of the proceeds” (at p 94). Applied literally, it would prevent insurance proceeds from being paid to any innocent beneficiary named in an insurance policy so long as the insured event was occasioned while the insured committed a criminal act. In this case, it would prevent Maria Oldfield’s claim. Feldman JA recognised at the Court of Appeal that Sopinka J did not hold that insurance contracts contain an implied term that criminal acts committed by the insured automatically exclude coverage even where the act is not committed with the intention of causing the insured loss. Likewise, he did not hold that there is a public policy rule that forbids payment to all beneficiaries, innocent or not, whenever the insured commits a criminal act. In Brissette, the insurance contract named the surviving spouse as beneficiary. The husband who murdered his wife committed a deliberate act intended to cause the insured event. There was no question that the husband was barred from receiving the proceeds; the Court had to decide whether the contract could be interpreted so as to vest the proceeds in the estate of the wife, or failing that, whether the device of a constructive trust could achieve the same result. The Court answered both of these questions in the negative. In

contrast to Brissette, the insured in the present appeal did not intend to cause the loss. Nor does Maria Oldfield, who was expressly designated as beneficiary under the contract, need to resort to trust principles in order to receive the proceeds. In total, Sopinka J’s decision in Brissette demonstrated that he did not intend to displace the principle that innocent beneficiaries who do not take through the criminal’s estate should not be affected by public policy. In Brissette, Sopinka J held that “[t]here is nothing unjust in refusing to pay the proceeds of insurance to a beneficiary not designated by the insurance contract when to do so would allow the insured to insure against his own criminal act” (p 95 (emphasis added)). Sopinka J reinforced this statement during his consideration of Cleaver, above, in which the insured took out an insurance policy on his own life with his wife as beneficiary. The wife-beneficiary then murdered the husband-insured. By statute, the proceeds were declared payable to the estate of the insured, to be held in trust for the beneficiary. Public policy prevented any payment from being made to the felonious wife-beneficiary but, in Sopinka J’s words, “[p]ublic policy was not allowed to abrogate a right that the estate had by virtue of the statute” (p 95). Applying this case to the facts in Brissette, Sopinka J held that “the result in Cleaver cannot be achieved in the absence of a provision, statutory or in the contract, providing for payment to the estate of the wife” (pp 95–96 (emphasis added). Because these passages appear after Sopinka J’s earlier statement that “a person should not be allowed to insure against his or her own criminal act irrespective of the ultimate payee of the proceeds” (p 94), it is clear that the earlier statement was not intended to be an open-ended change to the traditional public policy rule. A universal rule that “a person should not be allowed to insure against his or her own criminal act irrespective of the ultimate payee of the proceeds” would have serious

repercussions for bona fide creditors who provide value to obtain an interest in life insurance. Creditors in numerous instances such as a mortgage and other debt instruments will insist on obtaining an assignment of an insurance policy or being the named beneficiary sufficient to discharge the debt to protect their interest in the event of the debtor dying insolvent. If Sopinka J’s statement was given the broad interpretation that Transamerica seeks, bona fide creditors would be unable to obtain insurance proceeds where an insured died while committing a criminal act. To do so would run contrary to a long-standing principle that there is “no illegality in a stipulation that, if the policy should afterwards be assigned bona fide for a valuable consideration, or a lien upon it should afterwards be acquired bona fide for valuable consideration, it might be enforced for the benefit of others, whatever may be the means by which death is occasioned” (Moore v Woolsey (1854), 4 El & Bl 243 at p 255…The exception was not mentioned or considered in Sopinka J’s decision. In Brissette, Sopinka J did not intend to eliminate long established exceptions to the public policy rule. Brissette does not bar a claim by an innocent beneficiary where the insured does not intend the insured loss. In Home Insurance Co of New York v Lindal, [1934] SCR 33, [1934] 1 DLR 497, a passenger was injured when the intoxicated driver crashed his car. The passenger obtained judgment against the driver. The driver had insufficient assets to satisfy the judgment. Accordingly, the passenger brought an action to obtain indemnity from the insurer under section 180 of the Alberta Insurance Act, 1926. As well, the driver brought an action against the insurer to require it to indemnify him against his liability to the passenger. The Court held that the insurance company was not liable because it would be against public policy to indemnify the insured.

Transamerica argues that Lindal stands for the general proposition that where an insured contravenes any law, the insurance contract is unenforceable regardless of the identity of the beneficiary or claimant. It submits that it applies to Maria Oldfield’s claim so that her claim as beneficiary is against public policy. I agree with the Court of Appeal for Ontario’s decision in Stats that Lindal is distinguishable. In short, Lindal had nothing to do with innocent third party beneficiaries. For the insurance company to have provided the indemnity asked for in Lindal would have given a benefit to the criminal, namely, a discharge of the judgment the passenger had obtained against him. The passenger’s claim against the insurer under section 180 would have forced her to “stand in the shoes” of the insured in order to recover. As I have already stated, the public policy rule bars claims of those claiming through the wrongdoer. By contrast, where an innocent beneficiary is named in the insurance policy, no benefits accrue “to the insured or her estate as a result of the criminal act” (Stats, above, at p 244). (4) Section 118 of Ontario’s Insurance Act Transamerica relied on section 118 of Ontario’s Insurance Act, which states: “118. Unless the contract otherwise provides, a contravention of any criminal or other law in force in Ontario or elsewhere does not, by that fact alone, render unenforceable a claim for indemnity under a contract of insurance except where the contravention is committed by the insured, or by another person with the consent of the insured, with intent to bring about loss or damage, but in the case of a contract of life insurance this section applies only to disability insurance undertaken as part of the contract.”

Unless the contract otherwise provides, section 118 of the Insurance Act requires the insured to contravene a law and intend to bring about loss or damage for a claim for indemnity to be unenforceable. The exception does not apply to life insurance except for disability insurance undertaken as part of the contract. Transamerica argues that section 118 modifies the public policy rule as it applies to indemnity insurance but does not modify public policy as it applies to life insurance contracts. To explain the state of the public policy rule as it existed prior to section 118 of the Insurance Act, Transamerica referred to this Court’s decision in Lindal, above. Section 118 was first enacted in 1948…and was thought by some to be a legislative response to the Lindal decision. Transamerica argued that insofar as life insurance contracts are concerned, the public policy principles stated in Lindal continue unabated. As shown above, the first answer to this submission is that Lindal is distinguishable and provides no assistance to Transamerica. Moreover, section 118 simply addresses the effect that public policy is to have on indemnity contracts. Although section 118 states that “a contravention of any criminal or other law in force in Ontario or elsewhere does not, by that fact alone, render unenforceable a claim for indemnity under a contract of insurance”, it does not stand for the broader proposition that a contravention of any criminal or other law renders life insurance contracts unenforceable. Simply put, section 118 addresses how public policy does not affect indemnity insurance. It does not address how public policy affects life insurance. If “a contravention of any criminal or other law in force in Ontario or elsewhere” alone rendered life insurance contracts unenforceable, as Transamerica urges, the public policy rule would be significantly broadened. Section 118 is not limited to criminal acts. It includes the contravention of any law in force in Ontario or elsewhere. Therefore, if

jaywalking was the proximate cause of the life insured’s death, the public policy rule submitted by Transamerica’s interpretation of section 118 would prevent the proceeds from being paid to the insured’s family. It is for that reason that the public policy rule is limited to acts that are “sufficiently anti-social to justify the court’s refusing to enforce that right” (Hardy, above, at p 767). … (6) Rationale for the Public Policy Rule Two reasons have been advanced to support the public policy rule. One is that to enforce certain illegal contracts would “take away one of those restraints operating on the minds of men against the commission of crimes, namely, the interest we have in the welfare and prosperity of our connections” (Amicable Society v Bolland (1830), [1824–34] All ER Rep 570 (HL) (“Fauntleroy’s Case”), at p 572). In the present appeal, Transamerica seized the rationale of the first reason, and argued that to permit an innocent beneficiary to obtain insurance proceeds obtained through the commission of crime would encourage criminals to commit crimes. The argument goes that the criminal would enjoy a certain peace of mind if he or she knew that innocent beneficiaries would be protected and with that peace of mind, the criminal would be encouraged or would be more likely to commit crimes. Conversely, Transamerica argued that if a criminal knows that an innocent beneficiary will obtain no insurance proceeds where the criminal dies while committing a criminal act, crime might be discouraged. Over time, courts have criticised the idea that a less than strict application of public policy would encourage crime [he referred to Diplock LJ’s judgment in Hardy]. American courts too have criticised the rationale:

“The possibility that an affirmance of the judgment will promote evil or cause any considerable number of insureds to commit depredations on the public because of the comforting reassurance that their beneficiaries will collect the insurance if they are killed in the commission of crime is remote, speculative and theoretical. Both the public and the insurer have “a guaranty against increasing the risk insured, by that love of life which nature has implanted in every creature.” (Bird v John Hancock Mutual Life Insurance Co 320 SW2d 955 (Mo App 1959), at p 958). The second reason for the public policy rule simply recognizes that a court will not permit injustice. In Cleaver, Fry LJ explained that “no system of jurisprudence can with reason include amongst the rights which it enforces rights directly resulting to the person asserting them from the crime of that person” (p 156). Similarly, in In the Estate of Crippen (1911), [1911–13] All ER Rep 207, Evans P held that “[tlhe human mind revolts at the very idea that any other doctrine could be possible in our system of jurisprudence” (p 209). It is consistent with justice that innocent beneficiaries not be disentitled to insurance proceeds merely because an insured accidentally dies while committing a criminal act. Many decisions have recognized the long-standing principle (see eg Cleaver, at pp 159–60). To deny recovery would penalize the victim for the insured’s anti-social behaviour (C Brown, Insurance Law in Canada (looseleaf 1999), at pp 8– 28 to 8–29). (7) Exceptions to the Public Policy. Rule Will Not Encourage Crime To permit an innocent beneficiary to be entitled to insurance proceeds where an insured accidentally dies while committing a criminal act will not create a new cottage industry, where insurance companies vie to insure criminal

activities. If an insurance contract purported to cover an illegal activity, the contract would be unlawful and could not be enforced. There is a distinction between a contract that is illegal ab initio and a contract that is lawful in its inception but where the loss has arisen out of unlawful conduct (K Sutton, Insurance Law in Australia (3rd edn 1999), at p 1016): “The cases fall into two main categories: first, situations where the policy indemnifies the assured against the kind of loss he or she has suffered but such loss has, in the particular circumstances of the case, arisen out of conduct by the assured which is unlawful; and secondly, situations where the contract of insurance is itself illegal as infringing some common law or statutory provision. In the first category the contract is not itself unlawful but the claim based upon it may be, while in the second type of case it is the insurance contract itself which is called into question.” The distinction is further explained by reference to an example similar to the conduct at issue in this appeal (Sutton, above, at p 1043): “At common law the contract may clearly be unlawful, as in the case of insurance while in transit of an illegal consignment of drugs or cover against loss of profits if the operation of an illegal casino is disrupted by police action, and in such a case neither party has any cause of action under the contract. It would not lie in the mouth of either insurer or assured to allege that he was unaware of the illegality of the transaction. Where, however, the agreement is lawful on its face but is carried out in an illegal manner, the intentions of the parties are paramount, and a party who has not participated in the unlawful performance and whose intention is perfectly innocent may be able to enforce the contract. Even a guilty party may be able to rely on the

contract where the illegal act is held to be incidental to the main purpose of the contract.” Another textbook states that “[a] contract of insurance is illegal if it constitutes a contract to commit an illegal act or to reward someone for doing so, as if, for instance, the insurers undertook to indemnify the assured against the consequences of crimes which they knew he intended to commit…” (MacGillivray on Insurance Law, above, at p 320). Chitty on Contracts, vol 1 (28th edn 1999) states, at p 839: “Illegality may affect a contract in a number of ways but it is traditional to distinguish between (1) illegality as to formation and (2) illegality as to performance. Broadly speaking the first refers to the situation where the contract itself is illegal at the time it is formed, whereas the latter involves a contract which on its face is legal but which is performed in a manner which is illegal. In this latter situation it is possible for either both or only one of the parties to intend illegal performance. Where a contract is illegal as formed, or it is intended that it should be performed in a legally prohibited manner, the courts will not enforce the contract, or provide any other remedies arising out of the contract.” In the United States, some courts have concluded there is a world of difference between an insurance contract that explicitly insures crime and one that does not. In Weeks v New York Life Insurance Co 122 SE 586 (1924), the Supreme Court of South Carolina held that the position that “because an express contract to insure against death by legal execution would contravene public policy, an ordinary life policy which does not except death from such a cause should be declared unenforceable on grounds of public policy, is…clearly untenable” (p 588). Where an insured

“takes out an ordinary life insurance policy, to be matured by death from any cause, no basis in reason or experience exists for assuming that the insured had any intent at the time of making the contract to accelerate the maturity of the policy” by committing a crime (at p 588). If an insured and the insurer agreed to insure against the risk of death while carrying cocaine bags in the insured’s stomach, the contract could not be enforced by anyone, innocent beneficiary or not. By contrast, where the agreement is lawful on its face but carried out in an illegal manner, exceptions to the public policy apply. After all, public policy “does not make the policy void, it merely makes it unenforceable by the criminal” (J Lowry and P Rawlings, Insurance Law: Doctrines and Principles (1999), at p 168). (8) Is There a Need to Reform the Public Policy Rule? For the purposes of the present appeal, it is sufficient to conclude that an innocent beneficiary named in an insurance policy should not be disentitled to insurance proceeds where the insured dies while committing a criminal act and does not intend the loss. Public policy does not bar Maria Oldfield’s claim. Nevertheless, the distinction between an innocent beneficiary and those who claim through the criminal’s estate should be considered. Public policy has consistently refused to permit the criminal or those who claim through the criminal to obtain insurance proceeds. Those who claim through the criminal are denied, while innocent beneficiaries named in the policy are not. Ferguson J noted and I agree that the distinction seems arbitrary. As he held, “it is difficult to explain why a criminal can benefit his family by naming them as beneficiaries in an insurance policy but not by naming them in his will” (p 128). That there is an arbitrary distinction suggests the need to loosen the public policy rule rather than restrict it.

The public policy rule has gradually been modified. A trickle of reform occurred in Hardy, above. In Hardy, Diplock LJ proposed a public policy test that would balance the public policy interests at stake. He held (at pp 767–68): “The court’s refusal to assert a right, even against the person who has committed the anti-social act, will depend not only on the nature of the anti-social act but also on the nature of the right asserted. The court has to weigh the gravity of the anti-social act and the extent to which it will be encouraged by enforcing the right sought to be asserted against the social harm which will be caused if the right is not enforced.” In Saunders v Edwards, [1987] 1 WLR 1116 (CA), Bingham LJ expressed a similar balancing test (at p 1134): “…it is unacceptable that the court should, on the first indication of unlawfulness affecting any aspect of a transaction, draw up its skirts and refuse all assistance to the plaintiff, no matter how serious his loss nor how disproportionate his loss to the unlawfulness of his conduct.” In England, the public policy rule has been modified by the Forfeiture Act 1982 (UK), 1982, c 34. Under the Act, the court can modify the public policy rule, “having regard to the conduct of the offender and of the deceased”, “to such other circumstances as appear to the court to be material” and to “the justice of the case” (s 2(2)). Although the rule was modified by statute, Phillips LJ held that “the judges would themselves have modified the rule” if the legislature had not done so (Dunbar v Plant, [1997] 4 All ER 289 (CA), at p 310). He added that “the only logical way of modifying the rule would have been to have declined to apply it where the facts of the crime involved such a low

degree of culpability, or such a high degree of mitigation, that the sanction of forfeiture, far from giving effect to the public interest, would have been contrary to it” (p 310). Other courts have declined to modify the public policy rule, holding that it is up to the legislature to do so (Troja v Troja (1994), 33 NSWLR 269 (CA)). It might be appropriate to modify the public policy rule so as to permit an innocent person who claims through the criminal’s estate to take insurance proceeds. Indeed, in Hardy, Diplock LJ thought that the public policy rule could be modified to permit the criminal to take insurance proceeds, depending on “the nature of the anti-social act” and “the nature of the right asserted” (p 768). Under England’s Forfeiture Act 1982, courts can modify the effect of the forfeiture rule even where a person who has unlawfully killed another seeks to acquire a benefit in consequence of the killing. I leave the question to be decided either by the legislature or in another case where the issue arises. III. CONCLUSION In conclusion, public policy does not apply to bar a claim by an innocent beneficiary named in an insurance policy merely because the insured dies while committing a crime. Maria Oldfield’s claim is not barred by public policy or by any rule of contractual interpretation. In that light, I need not consider whether public policy rules are inapplicable because the insurance contract was obtained pursuant to a bona fide contract for value.’

[1119] Geismar v Sun Alliance and London Insurance Ltd [1978] QB 383 [Geismar brought items of jewellery into the UK without paying customs and excise duty, which was an offence that rendered the jewellery liable to forfeiture. When the jewellery was later stolen from his home, the insurers refused to pay on his claim. The court held for the insurers]. Talbot J: ‘I come now to the principal ground relied upon, namely: are the defendants relieved on grounds of public policy? The main point that emerges from these submissions [by counsel] is that the plaintiff insured will be in a better position and therefore derive an advantage by reason of the defendants’ indemnity. No authority need be cited to support the proposition that in general courts refuse to enforce a claim for a benefit which results from the commission of a crime or a tort or a claim to be indemnified against the consequences of such act, this being an application of the maxim ex turpi causa non oritur actio. It would be wrong, it was submitted, to allow the plaintiff to obtain a benefit or a profit and would be contrary to public policy because he would, in effect, be profiting from his crime of illegal importation of these articles… The application of this principle was sought in St John Shipping Corporation v Joseph Rank Ltd [1957] 1 QB 267. By section 44 of the Merchant Shipping (Safety and Load Line Conventions) Act 1932, merchant ships must not be loaded beyond a certain maximum depth. The facts were that a ship was overloaded and the defendant holders of a bill of lading in respect of part of its cargo withheld part of the freight moneys due and contended that the shipowners

were not entitled to recover that part which they had withheld as the charter had been performed in an illegal manner. Devlin J. considered the defendants’ submission that public policy demanded that that particular contract should be declared unenforceable because of the infringement of the Act of 1932, and for reasons that I need not go into held that that principle did not apply to that case. But what he did say, in the course of the argument of counsel, at p 274 was that he accepted the view that public policy was not a doctrine which ought to be extended in the sense of making new heads. It is quite plain…that it is of the highest importance that courts do not attempt to extend the doctrine of public policy in order to hold that contracts are unenforceable thereby, and that it is necessary to look to the accepted application of that doctrine and not go beyond that…Another case which foundered upon illegality was Parkin v Dick (1809) 11 East 502. In November 1807, the export of naval stores was forbidden by proclamation, and it was illegal to sail with such stores on board. In January 1808 a contract of insurance was entered into in respect of the cargo of a ship, part of which was made up of naval stores, the export of which was forbidden. It was held that the contract of insurance was unenforceable because it covered goods illegally exported even though it formed only a part of the total cargo on the ship… The question therefore remains: was this contract of insurance between the plaintiff and the defendants unenforceable because it was contrary to public policy as in Beresford v Royal Insurance Co Ltd [1938] AC 586 or that it was prohibited as in St John Shipping Corporation case [1957] 1 QB 267 and the other marine cases, or that it was a contract to cover goods illegally imported as in Parkin v Dick (1809) 11 East 502 (I have substituted “imported” for the word “exported”)? Again, is the contract unenforceable because the goods were smuggled into this country, as the dictum of Lord

Denning MR in Mackender v Feldia AG [1967] 2 QB 596 would appear to indicate, or because it was a collateral contract resulting from the illegal importation of the goods? The submissions made on behalf of the plaintiff included principally the submission that the importation of these goods was the background of the case but was in no way connected with the loss nor was it in any way concerned with the valuation of the insured’s interest. In fact, as between the parties, valuations in respect of the disputed items have been agreed between the parties, should the plaintiff succeed. Mr Cheyne pointed out that the only contract under consideration here was this contract of insurance and that by that contract of insurance it was his insurable interest that had to be considered and not his interest in the jewellery… Coming to transactions which are remote from the contract of insurance, where it was held that the insurance was not avoided by reason of illegality in an earlier transaction, I was referred to Bird v Appleton (1800) 8 Term Rep 562. One of the questions raised in that case was whether a contract of insurance was legal because it covered cargo which had been bought with the proceeds of a former illegal cargo. The Court of King’s Bench had little difficulty in holding that such a contract was legal. Lord Kenyon CJ said, at p 566: “If this objection were well founded, it would go to an alarming extent. In deciding on a claim made on a policy of insurance, it would be necessary to examine and scrutinise the past conduct of the assured, in order to see whether or not, by their former transaction in life, they had illegally acquired the funds with which the particular goods insured were purchased: but we cannot enter into considerations of that kind; we must confine ourselves to the immediate transaction before us…”

…If the plaintiff’s jewellery had been purchased by money illegally acquired that would have been no ground for avoiding the insurance contract. The question is therefore: why does not the same reasoning apply where the plaintiff’s jewellery was legally acquired, though smuggled into the country? Does one not have to look only at the contract of insurance? I turn now to the authority Alexander v Rayson [1936] 1 KB 169…Scott LJ, reading the judgment of the court, observed, at p 182: “It is settled law that an agreement to do an act that is illegal or immoral or contrary to public policy, or to do any act for a consideration that is illegal, immoral or contrary to public policy, is unlawful and therefore void. But it often happens that an agreement which in itself is not unlawful is made with the intention of one or both parties to make use of the subject matter for an unlawful purpose, that is to say a purpose that is illegal, immoral or contrary to public policy. The most common instance of this is an agreement for the sale or letting of an object, where the agreement is unobjectionable on the face of it, but where the intention of both or one of the parties is that the object shall be used by the purchaser or hirer for an unlawful purpose. In such a case any party to the agreement who had the unlawful intention is precluded from suing upon it. Ex turpi causa non oritur actio. The action does not lie because the court will not lend its help to such a plaintiff. Many instances of this are to be found in the books.” Scott LJ said, at the foot of p 183: “It will be observed that in all these cases the plaintiff was endeavouring to enforce by action an agreement, or a clause in an agreement, which was tainted by the unlawful intention of the plaintiff, or the unlawful intention of the

defendant known to the plaintiff, as to the purpose for which the subject matter of the agreement was to be used. To such an action the maxim, ex turpi causa non oritur actio applies. But the maxim does not require, nor does the language of it suggest, that a completely executed transfer of property, or of an interest in property, made in pursuance of such an agreement must be regarded as being invalid.” As I understand Mr Cheyne’s argument it was that the plaintiff had acquired property rights in his jewellery, albeit his possession of it was tainted with illegality and subject to confiscation and therefore his interest in his rights was insurable. He also relied on Gordon v Chief Commissioner of Metropolitan Police [1910] 2 KB 1080, where the defendant had seized money belonging to the plaintiff which had been acquired by street betting. The Street Betting Act 1906, while making street betting illegal, did not provide for forfeiture of moneys so acquired and the majority of the Court of Appeal held that the money belonged to the plaintiff and was his property and therefore there could be no application of the maxim ex turpi causa non oritur actio. It would seem, therefore, that if one acquires property, provided the actual acquisition is not unlawful and only the means whereby the receipt was brought about, then one would have the right to protect that property by resorting to the usual legal means. So here, argues Mr Cheyne, the law does not object to the acquisition and importation of goods, but it requires payment of duty in respect of them. So, just as Gordon could have insured the money against theft and recovered from the insurers, so also, it is submitted, can the plaintiff here recover on his insurance policy with the defendants. …One of the points made by Lord Halsbury LC [in Janson v Driefontein Consolidated Mines Ltd [1902] AC 484] was that it is not open to the court to deny a party his rights under

accepted law because the court has a notion that in his particular case it would be against the interests of the community. Secondly, in his view, the heads of public policy are fixed and known to the law and the court must not go beyond the known principles. Lord Davey, in the same appeal, said at p 500: “Public policy is always an unsafe and treacherous ground for legal decision.” In addition,…in Vita Food Products Inc v Unus Shipping Co Ltd [1939] AC 277. Lord Wright said, at p 293: “Nor must it be forgotten that the rule by which contracts not expressly forbidden by statute or declared to be void are in proper cases nullified for disobedience to a statute is a rule of public policy only, and public policy understood in a wider sense may at times be better served by refusing to nullify a bargain save on serious and sufficient grounds.” …Applying these cases to the present problem it would seem that a contract of insurance, which is separate and apart from the illegal act, is not rendered unenforceable, but if the contract of insurance purports to cover property which the law forbids him to have, then the contract is directly connected with the illegal act and is unenforceable. In the present case it is argued that the plaintiff’s contract of insurance is quite apart from and does not in any way spring from his illegal act of importation of some of the articles insured under the policy. Moreover, the law of this country does not forbid possession of property brought in from foreign countries. What it requires is that the importer shall pay for its importation. The fact that property is liable to confiscation under the relevant Act does not negative the plaintiff’s right of property in it until the act of confiscation is carried out. All these authorities, with their application to problems related to the present one, though of assistance, do not cover the precise point. I start with the fact that the

contracts of insurance are separate from the illegal importation. Next, there is no contractual point taken here and there has been no repudiation of the contracts by the defendants. It is clear that the plaintiff has an insurable interest in the property, though subject to defeasance. It is also clear that to allow the plaintiff to recover under the policies would be to allow him to recover the insured value of the goods which might have been confiscated at any moment and which, therefore, were potentially without value to him. So far as the defendants were concerned, they being unaware of the illegal importation, the policies were not tainted with illegality, but the question is: ought the court to enforce these policies against them in favour of the plaintiff? It seems to me that from what Lord Denning MR said in Mackender v Feldia AG [1967] 2 QB 590 the policies would be unenforceable, provided that to enforce them would conflict with public policy. So these smuggled articles are in the same category as the forbidden cargo in Parkin v Dick (1809) 11 East 502. No new area of public policy is involved here. The plaintiff is seeking the assistance of the court to enforce contracts of insurance so that he may be indemnified against loss of articles which he deliberately and intentionally imported into this country in breach of the Customs and Excise Act 1952. I am not concerned with cases of unintentional importation or of innocent possession of uncustomed goods. I would think that different considerations would apply in those cases. But where there is a deliberate breach of the law I do not think the court ought to assist the plaintiff to derive a profit from it, even though it is sought indirectly through an indemnity under an insurance policy.’

[1120] Euro-Diam Ltd v Bathurst [1990] 1 QB 1 (CA)

[Euro-Diam, a UK company supplying precious stones to wholesalers, entered into a contract of indemnity insurance with the insurer Bathurst, which covered an export of diamonds to West Germany. Those stones were stolen from a warehouse in Germany. The diamonds were part of consignments negotiated by an Israeli citizen who was engaged in business in contravention of West German immigration laws. Bathurst denied liability, claiming, among other things, that Euro-Diam had misrepresented the value of one of the consignments on the invoice sent to the German company to enable that company to evade West German import tax. Bathurst was held liable.] Kerr LJ (with whom Russell LJ and Sir Denys Buckley concurred): ‘…I propose to refer to the submissions raised on behalf of the defendant in this case compendiously as the “ex turpi causa defence.” In my view the relevant principles can then be summarised as follows: (1) The ex turpi causa defence ultimately rests on a principle of public policy that the courts will not assist a plaintiff who has been guilty of illegal (or immoral) conduct of which the courts should take notice. It applies if in all the circumstances it would be an affront to the public conscience to grant the plaintiff the relief which he seeks because the court would thereby appear to assist or encourage the plaintiff in his illegal conduct or to encourage others in similar acts: see (2)(iii) below. The problem is not only to apply this principle, but also to respect its limits, in relation to the facts of particular cases in the light of the authorities. (2) The authorities show that in a number of situations the ex turpi causa defence will prima facie succeed. The

main ones are: (i) where the plaintiff seeks to, or is forced to, found his claim on an illegal contract or to plead its illegality in order to support his claim: see eg Bowmakers Ltd v Barnet Instruments Ltd [1945] KB 65, 71. For that purpose it makes no difference whether the illegality is raised in the plaintiff’s claim or by way of reply to a ground of defence: Taylor v Chester (1869) LR 4 QB 309, as there cited… (ii) Where the grant of relief to the plaintiff would enable him to benefit from his criminal conduct… (iii) Where, even though neither (i) nor (ii) is applicable to the plaintiff’s claim, the situation is nevertheless residually covered by the general principle summarised in (1) above. This is most recently illustrated by the judgment of Hutchison J in Thackwell v Barclays Bank Plc [1986] 1 All ER 676, in particular at pp 687, 689, as approved by this court in Saunders v Edwards [1987] 1 WLR 1116, 1127 and 1134, and in particular per Nicholls LJ, at p 1132. (3) However, the ex turpi causa defence must be approached pragmatically and with caution, depending on the circumstances: see eg per Bingham LJ in Saunders v Edwards, at p 1134. This applies in particular to cases which at first sight appear to fall within (2)(i) or (ii) above. Thus: (a) situations covered by (2)(i) above must be distinguished from others where the plaintiff’s claim is not founded on any illegal act, but where some reprehensible conduct on his part is disclosed in the course of the proceedings, whether by the plaintiff himself or otherwise: see eg Pye Ltd v BG Transport Service Ltd [1966] 2 Lloyd’s Rep. 300 (to which I refer again later); St John Shipping Corporation v Joseph Rank Ltd [1957] 1 QB 267; Belvoir Finance Co Ltd v Stapleton [1971] 1 QB 210 and Saunders v Edwards

[1987] 1 WLR 1116. In such cases the ex turpi causa defence will not succeed. Nor will it succeed where the defendant’s conduct in participating in an illegal contract on which the plaintiff sues is so reprehensible in comparison with that of the plaintiff that it would be wrong to allow the defendant to rely on it: see eg, Shelley v Paddock [1979] QB 120. But where both parties are equally privy to the illegality the plaintiff’s claim will fail, whether raised in contract or tort, for potior est condicio defendentis. Ashmore, Benson, Pease & Co Ltd v AV Dawson Ltd [1973] 1 WLR 828 is an illustration of such a situation and an action on a contract whose terms are falsely recorded in documents intended to conceal the true agreement between the parties may be defeated by the ex turpi causa defence: see eg, Alexander v Rayson [1936] 1 KB 169. (b) In situations covered by (2)(i) and (ii) above the ex turpi causa defence will also fail if the plaintiff’s claim is for the delivery up of his goods, or for damages for their wrongful conversion, and if he is able to assert a proprietary or possessory title to them even if this is derived from an illegal contract: see eg, Bowmakers Ltd v Barnet Instruments Ltd [1945] KB 65, Belvoir Finance Co Ltd v Stapleton [1971] 1 QB 210 and Singh v Ali [1960] AC 167. (4) Most of the situations and authorities referred to in (1) to (3) above have no direct application between the plaintiffs and the defendant in the present case, because the insurers were obviously entirely innocent throughout, and because the contract of insurance sued upon by the plaintiffs was in itself wholly unaffected by any illegality. But they were nevertheless debated on this appeal, for two reasons. First, an illegality involving one contract or transaction can have the effect of tainting the plaintiffs’ claim under another related contract, so that the ex turpi causa defence still has to

be considered in relation to his claim under the latter contract: see eg, Pye Ltd v BG Transport Service Ltd [1966] 2 Lloyd’s Rep 300 where the defence failed, and Spector v Ageda [1973] Ch 30 and Geismar v Sun Alliance and London Insurance Ltd [1978] QB 383 where it succeeded. For that purpose it is relevant to consider the effect of the understated invoice on the contract between the plaintiffs and Verena. Secondly, Mr Malins raised a new point which had not been argued below. He submitted that, for the purpose of considering the applicability of the ex turpi causa defence to the plaintiffs’ claim under the insurance policy, one also had to bear in mind that the insurers’ rights of subrogation might turn out to be prejudiced. If, for instance, the insurers were to sue Verena in the plaintiffs’ name in conversion or negligence for the loss of the diamonds, and if Verena were thereupon to rely on the understated invoice as a basis for raising the ex turpi causa defence, then — as Mr Malins claimed and Mr Gruder denied — the insurers’ subrogated claim would be defeated as the result of Mr Laub’s unlawful act. The foregoing matters, particularly those referred to in (3)(a) and (b) above, would then have to be considered. and even if Verena were to fail to establish the ex turpi causa defence, Mr Malins said that the understated invoice would still have the consequence that the insurers would be faced with much greater difficulty in pursuing any subrogated claim as the result of Mr Laub’s infraction of German law. With the exception of the subrogation point mentioned in (4) above the judge considered all the submissions raised by the foregoing summary. He concluded that the ex turpi causa defence fails in this case. I entirely agree with his conclusion and can summarise my reasons as follows. (A) Mr Laub’s issue of the understated invoice was undoubtedly reprehensible. He realised that it would

probably be used to deceive the German customs, and his action was criminal under the laws of the Federal Republic. But he did not issue the invoice for his own or the plaintiffs’ purposes, but at the request of Mr Bonim. Subject to the argument on subrogation to which I come in a moment, the understated invoice had no bearing on the loss of the diamonds, which is now admitted to have been covered by the plaintiffs’ policy. The understated invoice also involved no deception of the insurers, since the true value of the diamonds was recorded in the plaintiffs’ register and the correct premium was paid. In these circumstances there could in my view be no question of any affront to the public conscience, on the lines referred to in paragraphs (1) and (2)(iii) above, if the plaintiffs’ claim were to be upheld. On the contrary, it might be considered surprising if in these circumstances the insurers were entitled to refuse payment. But even if that is putting it too high, I have no doubt that public policy does not require the court to hold that the plaintiffs’ claim must be rejected in limine on the basis of the ex turpi causa defence. (B) For the purposes of their claim under their policy the matters referred to in paragraph (2)(i) above have no application. Mr Malins strenuously argued the contrary, claiming that the plaintiffs could not prove consignment of the diamonds to Verena without relying on the invoice showing the number of carats dispatched. He also said that in order to show that the title in the diamonds remained in the plaintiffs, Mr Laub would have to give evidence that the contract was sale or return, and that in these circumstances Mr Laub would have to rely upon, or at any rate to disclose, all the terms of the contract without picking and choosing, including his

agreement to understate the value of the goods. But I do not accept any of these submissions. They appear to me to be covered by the first part of paragraph (3)(a) above. In particular, the plaintiffs did not have to rely on the invoice to establish their claim, since the policy provided that the basis of valuation should be “as per register,” and since the plaintiffs’ register contained a correct record of the value. (C) Equally, the matters referred to in paragraph (2)(ii) above are not applicable to the plaintiffs’ claim under the policy. They derived no tangible benefit from the understated invoice. In St John Shipping Corporation v Joseph Rank Ltd [1957] 1 QB 267 Devlin J appears to have considered that the ex turpi causa defence cannot be asserted unless the defendant is able to show to what extent the plaintiff derived a benefit from his illegality: see at pp 292–93. It may be that this goes too far. But in the present case the possible goodwill advantage to the plaintiffs of having acceded to Mr Bonim’s request is so shadowy that it is not surprising that the judge made no mention of it at all. Although I felt bound to accept Mr Malins’ submission that the potential benefit of the understated invoice was not exclusively on the side of Verena, the impact of this aspect is virtually negligible. (D) I then turn to the position as between the plaintiffs and Verena in so far as this may be relevant. I have great difficulty in seeing how Verena could successfully rely on the ex turpi causa defence in relation to almost any claim by the plaintiffs against Verena that one can imagine, assuming that English law would apply or that German law is the same. Mr Bonim would clearly have to be treated as having acted on behalf of Verena in asking for the

understated invoice, and in any event Verena must be treated as having ratified his conduct when they used it to deceive the German customs, as the judge held they did. It follows that on the question of public policy and the relative culpability of the parties the scales would be heavily weighted against Verena. They alone made a tangible profit out of the transaction. An action against Verena for conversion or for the negligent loss of the diamonds would in my view succeed on the basis of the authorities referred to in paragraphs (3)(a) and (b) above. The only situation in which I could envisage that the plaintiffs would be in the difficulty of having to rely upon the understated invoice is an ingenious scenario suggested by Mr Malins. He said that if Verena failed to return the diamonds and failed to pay the price, and if the plaintiffs thereupon sued them for the price, Verena might merely pay the amount stated in the invoice, and that it would then not be open to Mr Laub to contradict the invoice by relying on the true agreed price. But whether or not this is correct — and it is unnecessary to express any view about it — is irrelevant to the plaintiffs’ claim in this action. Since any failure on the part of Verena to return the diamonds or to pay the agreed price was not a risk insured under the plaintiffs’ policy, there could be no question of the plaintiffs’ insurers claiming payment of their price by subrogation. (E) These matters also deal with Mr Malins’ new point on the alleged prejudice to the insurers’ rights of subrogation. But in any event it seems to me that this line of argumentation goes too far. The successful exercise by underwriters of their full rights of subrogation is often impossible; in many

cases due to acts or omissions by their assured. Admittedly, in this case there was no question of Mr Laub having merely acted negligently. His conduct was unlawful by German law and in effect dishonest. But if underwriters wish to exclude their liability in such circumstances, and if they cannot succeed on the grounds of public policy already discussed, then their remedy must be to include some appropriate term in the policy. The mere fact that the understated invoice might prove an embarrassment to them in any subrogation proceedings concerning the diamonds, as Mr Gruder frankly conceded it might, cannot in itself be sufficient to tip the scales of public policy in their favour. (F) It follows that in my view the present case is analogous to the decision of Browne J in Pye Ltd v BG Transport Service Ltd [1966] 2 Lloyd’s Rep 300 and I do not accept the suggestion that that case was wrongly decided. The plaintiff sellers had agreed with their buyers that the goods, which were to be shipped to Persia, would be invoiced at less than the true price in order to deceive the Persian customs authorities. That involved the plaintiffs in breaches of English law under the Customs and Excise Act 1952 and to that extent that case is a fortiori to the present case. The goods were stolen in this country while they were in the custody of the defendant carriers. They relied unsuccessfully on the false invoice and the ex turpi causa defence… That only leaves the decision of Talbot J in Geismar v Sun Alliance and London Insurance Ltd [1978] QB 383 which was Mr Malins’ sheet-anchor… [Aside from the point about confiscation, there are] at least two grounds of distinction. First, following the old case of Parkin v Dick (1809) 11 East 502, to which Talbot J referred in the Geismar case [1978]

QB 383, 395D, it may be that a special rule of public policy applies to a claim for an insured loss of articles whose importation and possession in this country is prohibited. We heard no argument on that aspect and I do not discuss it further. Secondly, however, as the judge held in the present case…I think that the ratio of the Geismar case is to be found in the penultimate sentence of the judgment [1978] QB 383, 395F: “But where there is a deliberate breach of the law I do not think the court ought to assist the plaintiff to derive a profit from it, even though it is sought indirectly through an indemnity under an insurance policy.” I therefore conclude that the Geismar case was correctly decided on the basis of the principle and the authorities referred to in paragraph (2)(ii) above. Furthermore, from the point of view of public policy the plaintiff’s position in the Geismar case was obviously very different from the position of the plaintiffs’ in the present case. The plaintiff was in possession of goods which he had effectively smuggled into this country, and on which he had evaded customs duty which he made it clear he would not pay. By his claim he sought to recover the value of these goods in this country, which would presumably include the unpaid duty. The plaintiffs, on the other hand, did not smuggle the diamonds into Germany and did not themselves make use of the understated invoice; they were not liable for the underpaid tax; and they did not have the goods in their possession at any relevant time. For all these reasons I am in full agreement with the judge that the ex turpi causa defence fails. In these circumstances we found it unnecessary to hear Mr Gruder on another aspect raised by way of cross-appeal, although the judge also dealt with this. This concerned the question whether, if

the plaintiffs were to fail on the matters already discussed, they could nevertheless succeed because Mr Laub’s issue of the understated invoice did not constitute any breach of English law but only of German law, and of a German revenue law at that. The judge rejected this…Although we have heard no argument on the point I have no doubt that his conclusion was right. It would be extraordinary if our law were to countenance an agreement involving the commission of a criminal offence in a friendly foreign country with impunity by holding that on that ground the agreement is not to be regarded as contrary to public policy. Regazzoni v KC Sethia (1944) Ltd [1958] AC 301 is a sufficient answer to this contention, which appears to fly in the face of all principles of comity. and as regards the point that Mr Laub’s action constituted an offence under a foreign revenue law, as Denning LJ said in Regazzoni v KC Sethia (1944) Ltd [1956] 2 QB 490, 515, 516, while our courts do not enforce such laws, they will obviously not assist in their breach.’

Notes: 1. Kerr LJ used the public conscience test, by which he meant that ‘the ex turpi causa defence… applies if in all the circumstances it would be an affront to the public conscience to grant the plaintiff the relief which he seeks because the court would thereby appear to assist or encourage the plaintiff in his illegal conduct or to encourage others in similar acts’. This principle was rejected by the House of Lords in a non-insurance case, Tinsley v Mulligan [1994] 1 AC 340, where Lord Goff mounted a comprehensive demolition of the idea and Lord Browne-Wilkinson remarked, ‘the consequences

of being a party to an illegal transaction cannot depend…on such an imponderable factor as the extent to which the public conscience would be affronted by recognising rights created by illegal transactions.’ He went on to say, ‘In my judgment the time has come to decide clearly that the rule is the same whether a plaintiff founds himself on a legal or equitable title: he is entitled to recover if he is not forced to plead or rely on the illegality, even if it emerges that the title on which he relied was acquired in the course of carrying through an illegal transaction.’

See N Cohen, “The Quiet Revolution in the Enforcement of Illegal Contracts” [1994] LMCLQ 163; H Stowe, “The ‘Unruly Horse’ has Bolted; Tinsley v Mulligan” (1994) 57 MLR 441. 2. There remains the problem of one co-insured intentionally causing the loss in circumstances which would preclude that person from claiming. In Economy Fire and Casualty Company v Warren 390 NE2d 361 (Appellate Court of Illinois, 1979), the insurers settled a fire loss claim with the insureds, who were a husband and wife. Shortly afterwards, the wife admitted that she had intentionally set fire to the dwelling. The insurers sought repayment of the entire payment. It was held that the husband was innocent of any wrongdoing and the wife’s act should not be imputed to him so

as to bar his recovery. Therefore, the husband, as an innocent co-insured, was entitled to onehalf of the insurance proceeds, but the insurers were entitled to an equitable lien against the wife to the extent of the payment to the husband.

11.3 Third Party Claims In chapter 6 we considered the requirement of insurable interest in property insurance. A further issue that arises is whether or not a third party, such as a union member in the Prudential Staff Union case (see chapter 6, [630]) or the claimant’s sister in Williams v Baltic Insurance Association of London (see chapter 6, [631]), could have claimed directly under the policy. A major hurdle would have been the doctrine of privity of contract unless the insured could establish that he or she effected the policy as agent or trustee of the third party. The decision in Vandepitte (below, [1121]) illustrates the harsh consequences which the privity doctrine could produce. However, for insurance contracts concluded (or renewed) after 11 May 2000 the privity point may be redundant because the Contracts (Rights of Third Parties) Act 1999 may give the third party the right to claim directly (see [1122]) — provided, of course, the operation of the Act is not excluded by the parties. The 1999 Act is based on the Law Commission’s Report No 242, Privity of Contract: Contracts for the Benefit of Third Parties (London, The

Stationary Office, 1996); see J Hanson and V Flynn, “Cutting through the confusion? The rights of third parties under insurance and reinsurance contracts” (1997) 1 JIL 50; and R Merkin (ed) Privity — the Impact of the Contracts (Rights of Third Parties) Act 1999 (London, LLP, 1999). [1121] Vandepitte v Preferred Accident Insurance Corporation of New York [1933] AC 70 (PC) [The insured, RE Berry, had effected a motor policy against third party risks which extended indemnity cover to any person driving the insured’s car with his consent. Vandepitte, the third party, had successfully sued the insured’s daughter, Jean Berry, for personal injuries caused by her negligence while driving her father’s car with his permission. Vandepitte sought to recover from the insurers, by virtue of section 24 of the Insurance Act 1925, British Columbia, the amount of unsatisfied judgment which she had obtained. It was argued, inter alia, that the father was trustee with respect to the additional risk covered. The Privy Council distinguished Williams v Baltic Insurance Association, see chapter 6, [631]]. Lord Wright: ‘The first mode of stating the appellant’s case involves that RE Berry as his daughter’s agent made a contract of insurance between her and the respondents. But a contract can arise only if there is the animus contrahendi between the parties; there is here no evidence that Jean Berry ever had any conception that she had entered into any contract

of insurance. She certainly took no direct part in the conclusion of whatever contract there was. The policy was entirely arranged between RE Berry and the respondents, and he alone filled in and signed in his own name and behalf the application… In the present case there is no evidence that RE Berry had any intention to insure any one but himself; even if in some cases the words of the policy taken with the surrounding circumstances might be held to found the necessary inference of intention that inference would fail here by reason of the statutory application. But even if he had so intended, he had no authority from Jean Berry to insure on her behalf and at no time did she purport to adopt or ratify any insurance even if made on her behalf. In these circumstances it is impossible to say that a contract existed between Jean Berry and the respondents, that is, it cannot be held that she was in law “insured” under the policy. This conclusion is arrived at quite apart from the provision of section 153 of the [Insurance Act 1925, of British Columbia], which requires the insured’s name and other particulars to be inserted in the policy. It is also arrived at apart from the form of the policy, which throughout, in referring to the insured, refers back as a matter of construction to the named insured RE Berry, who filled in the statutory application form. The very clause on which the contention is based draws a pointed distinction merely as matter of words between “the insured” and “any person or persons riding, etc.” and between the named insured and “the other persons entitled to indemnity under the terms of this section.” Furthermore there was no consideration proceeding from Jean Berry. It is, however, argued on behalf of the appellant that even if their Lordships should hold, as they do, that Jean Berry was not a party in law to the insurance contract, she was a party in equity, and in that way was “insured” by the

respondents within the meaning of section 24. These two steps of the argument require separate consideration. The contention firstly is that RE Berry, as part of the bargain and for consideration proceeding from him, stipulated that the respondents should indemnify his daughter, Jean Berry, as coming under the general words of description, in the same manner and under the same conditions as himself, that is, that he created a trust of that chose in action for her as beneficiary. It cannot be questioned that abstractly such a trusteeship is competent. No doubt at common law no one can sue on a contract except those who are contracting parties and (if the contract is not under seal) from and between whom consideration proceeds: the rule is stated by Lord Haldane in Dunlop Pneumatic Tyre Co v Selfridge & Co [1915 AC 847, 853…The trustee then can take steps to enforce performance to the beneficiary by the other contracting party as in the case of other equitable rights. The action should be in the name of the trustee; if, however, he refuses to sue, the beneficiary can sue, joining the trustee as a defendant. But, though the general rule is clear, the present question is whether RE Berry can be held in this case to have constituted such a trust. But here again the intention to constitute the trust must be affirmatively proved: the intention cannot necessarily be inferred from the mere general words of the policy… In the present case, there are not only the difficulties arising from the statutory provisions quoted above, but there is no evidence that RE Berry had any intention to create a beneficial interest for Jean Berry, either specifically or as member of a described class. Indeed, at no time either when the policy was effected or before or after the accident is there any suggestion that RE Berry had any such idea. It is true that she was in the habit of driving the insured automobile, but if RE Berry read the clause or thought of the matter at all, he would naturally expect that if she did

damage the claim would, under the Act quoted, be against him, as she was a minor living in his family. There is a further difficulty in the appellant’s way under this head: RE Berry is the contracting party in law, but he has no insurable interest in Jean Berry’s personal liability, since natural love and affection does not give such an interest in law. Whenever she drove the car, if she was an insured person, she had an insurable interest in the chance that she might be held liable in damages for negligence, but on the assumption now being considered — namely, that she was no more than a cestui que trust in regard to the insurance — the contracting party was RE Berry, who had no insurable interest: hence the policy, in respect of that particular risk, was void under the express words of [the 1925 Act]. No doubt it has been held as a special rule in certain cases that a person having a special property in goods can insure on behalf and for the benefit of other persons interested as well as for his own benefit, as is illustrated by…Waters v Monarch Life and Fire Assurance Co, but here no question of a special property in goods was involved: RE Berry had no insurable interest in the possible liability of his daughter. But if it is to be said that the cestui que trust is to be treated as if in law the contracting party, then Jean Berry must have satisfied the requirements of the statute, as being the “insured”…which it cannot be said that she did. There is a further objection to applying to her case the idea of her being the cestui que trust under the policy, since the doctrine of the equitable interest of a beneficiary under a contract of a third party relates to benefits under the contract, whereas in an insurance such as that contended for serious duties and obligations rest on any person claiming to be insured, which necessarily involve consent and privity of contract. Their Lordships are of opinion that no trusteeship is here made out, but in any case they could not hold that the provisions of section 24 were satisfied by anything but a

contract at law, enforceable directly against the insurers by the insured in her own name…In their Lordships’ opinion, an equitable right in Jean Berry (even if it were constituted) enforceable only in the name of the statutory insured, RE Berry, would not satisfy section 24, which involves an added burden on the insurance company, and must be strictly construed.’

[1122] Contracts (Rights of Third Parties) Act 1999 (1999 Chapter c 31) ‘An Act to make provision for the enforcement of contractual terms by third parties. Section 1 (1) Subject to the provisions of this Act, a person who is not a party to a contract (a “third party”) may in his own right enforce a term of the contract if — (a) the contract expressly provides that he may, or (b) subject to subsection (2), the term purports to confer a benefit on him (2) Subsection (1)(b) does not apply if on a proper construction of the contract it appears that the parties did not intend the term to be enforceable by the third party. (3) The third party must be expressly identified in the contract by name, as a member of a class or as answering a particular description but need not be in existence when the contract is entered into… Section 3 (1) [where]…in reliance on section 1, proceedings for the enforcement of a term of a contract are brought by a third party.

(2) The promisor shall have available to him by way of defence or set-off any matter that (a) arises from or in connection with the contract and is relevant to the term, and (b) would have been available to him by way of defence or set-off if the proceedings had been brought by the promisee. (3) The promisor shall also have available to him by way of defence or set-off any matter if — (a) an express term of the contract provides for it to be available to him in proceedings brought by the third party, and (b) it would have been available to him by way of defence or set-off if the proceedings had been brought by the promisee…’

Notes: 1. Taken together, sections 1(1)(a) and 1(1)(b) and (2) enable a third party to enforce a contract term that confers a benefit on him or her unless it appears on “a proper construction” of the agreement that the parties did not intend it to be so enforceable. Thus, bailees and sub-contractors would now be able to enforce the policy by virtues of section 1(1)(b). 2. Section 1(3) requires the third party to be expressly identified by name or as a member of a particular class, although such class need not be in existence when the contract is concluded. 3. By section 3 any defences available to the insurer against the insured, for example non-disclosure, misrepresentation or breach of warranty or condition, are also available against the third party. 4. It should be noted, however, the contracting parties may exclude the operation of the Act. It is therefore open to insurers to insert such a clause in their

policies. In such cases the trust devise on the one hand, or agency principles on the other, may continue to hold the potential to allow enforceability by a third party; although in the case of the trust there is now some doubt as a result of the decision in Re Dibbens & Sons Ltd [1990] BCLC 577, (discussed by Hobhouse LJ in DG Finance Ltd v Scott (below, [1123]), notwithstanding dicta to the contrary expressed by Lord Wright in Vandepitte. The legal basis of a third party’s claim to the proceeds of insurance was considered by Hobhouse LJ:

[1123] DG Finance Ltd v Scott Eagle Star Insurance [1999] Lloyd’s Rep IR 283 (CA) [The claimants were a finance company and had hired a new trailor to the defendant, Mr Scott, for use in his business as a haulier. The hire agreement was for a period of five years and it required the defendant to obtain insurance cover for the vehicle. He effected a policy with Eagle Star against theft, liability for third party injury and property damage. Cover was limited to the market value of the trailor at the time of loss. When the vehicle was returned to the suppliers for alterations it was stolen from their premises. The defendant stopped paying the hire fee and the claimants cancelled their agreement. They sued him for the outstanding sum owing, £25,469.83, and obtained judgment. Meanwhile, the defendant had been declared bankrupt and the suppliers had gone into liquidation. The claimants therefore joined Eagle Star as second defendants on the basis that Mr Scott held the policy on trust for them and Eagle Star

were bound to indemnify them against loss; in the alternative they claimed that the defendant held the policy under a fiduciary obligation. The claimants argued that since Mr Scott had failed to enforce the policy they could do so as beneficiaries of the trust or fiduciary obligation and that the defendant was bound to account to them for recovery under the policy]. Hobhouse LJ: ‘The legal position of Mr Scott What then is the position in law? It is governed by the clarification of the law contained in the speeches in Tomlinson v Hepburn… The present policy was a policy upon goods. The trailer having been lost by a peril insured against, the assured bailee (Mr Scott) is entitled to be paid the full insured value of the trailer by the insurers (Eagle Star). In so far as his recovery exceeds his interest he is liable to account to his bailor, the owner of the trailer (the plaintiffs). The use of the word “trust” in this context was explained by Lord Diplock in The Albazero [1977] AC 774 at 845: My Lords the rule does not fit easily into the law of trusts as it has been developed by the Courts of Equity. It has never been suggested that the consignor’s right of action against the carrier for breach of contract constitutes trust property or that he could be compelled by a Court of Equity to exercise his right of action for the benefit of those persons who had in fact suffered actual loss as if they were said to be cestuis que trustent. Whatever rights they have spring up when the consignor has recovered judgment and their remedy before the merger of law and equity would appear to have been an action at common law in indebitatus

assumpsit for money had and received by the consignor to their use: see Moses v Macferlan (1760) 2 Burr 1005. The use of the word “trust” in the context of an insured bailee’s obligation to account to his bailors was also considered by Harman J in Re Dibbens [1990] BCLC 577, where the insolvent company of warehousemen had stored customers’ furniture; the relevant customers had paid the company to insure the furniture. Harman J held that this gave rise to a fiduciary obligation on the part of the company to those customers to have a fund out of which their losses could be met and to pay their losses out of the moneys which the insurers had paid to the company. Thus, as it seems to me, one does not have here a true trust relationship at all; one has a relationship of fiduciary obligation which can be satisfied out of the insurance fund available to pay those persons who contracted with the company to have their goods insured…The policy moneys were not held as a trust fund nor was the policy, as a chose in action, trust property. The liability of Eagle Star is a liability to Mr Scott. Mr Scott will have a liability to account to the plaintiffs for his recovery from Eagle Star to the extent that his recovery exceeds his own loss. This principle does not without more give the plaintiffs any direct rights against Eagle Star; it gives the plaintiffs rights against Mr Scott in respect of whatever recovery he may receive from Eagle Star. The plaintiffs also cited what Diplock LJ said in Re King [1963] Ch 459, at p 499. Diplock LJ, referring to the principle that a policy without interest is a wagering policy and void, said that where a bailee insured goods it might therefore be inferred that he was insuring as agent for the bailor; where he was under an obligation so to insure the goods bailed, there would be a strong inference that this was what he has done. The judgments in Re King now need to be read with what was said in Tomlinson v Hepburn which shows that

their reasoning is open to question. The plaintiffs’ submission certainly cannot be treated as a basis for a summary judgment in their favour and, as I have stated earlier, the present evidence does not support the case of agency.’

Notes: 1. There are also statutory exceptions to the privity rule. For example, section 11 of the Married Women’s Property Act 1882, creates a statutory trust whereby on the death of a married insured, insurance monies are paid direct to the surviving spouse (see chapter 7). The advantage of the statutory trust is that the insurance monies do not form part of the deceased’s estate and are not, therefore, subject to creditors’ claims. Other exceptions include the Third Parties (Rights Against Insurers) Act 1930 (see Part 11.4 below) and the Fires Prevention (Metropolis) Act 1774 (see chapter 13, below). 2. An additional means of avoiding the trap posed by the privity rule is to enlist the undisclosed/unnamed principal doctrine. See Birds, “Agency and insurance” [1994] JBL 386. [1124] Siu Yin Kwan v Eastern Insurance Co Ltd [1994] 2 AC 199 (PC) [The claimants, personal representatives of two seamen who were killed when the vessel on which they were working was hit by a typhoon, successfully sued the shipowner, Axelson Co Ltd, for damages.

Before they were paid the shipowning company was wound up and their judgments were not satisfied. The company had taken out employer’s liability insurance with the defendants. Hong Kong law provides that where a company which is insured against liabilities to third parties is wound up ‘if…any such liability…is incurred by the insured, his rights against the insurer under the contract in respect of the liability shall…be transferred to and vest in the third party to whom the liability was so incurred’ (section 2(1) of the Third Parties (Rights against Insurers) Ordinance (c 273)). The defendants argued that because the insurance was effected on behalf of the company by shipping agents, Richstone Industries Ltd, who were described in the policy as the insured, they were not liable]. Lord Lloyd: ‘Richstone Industries Ltd. was formed in Hong Kong in the early part of 1980 to carry on business as shipping agents. The managing director was Pak Chung King (“Mr Pak”). The managing director of the insurers was Tung Kie Wei (“Mr Tung”). Mr Tung and Mr Pak had known each other for many years. In November 1980 Axelson appointed Richstone as their agent to look after the Barquentine Osprey in Hong Kong. Towards the end of 1981 Axelson instructed Richstone to obtain hull insurance on the Barquentine Osprey. Mr Pak consulted the insurers. The insurers were unable to issue a policy for reasons which do not matter. But as a result of the approach the insurers knew that Richstone were acting as agents for the owners. By an agreement dated 23 March 1982 Axelson appointed Richstone to act as their general agents worldwide. By clause 2(d) of the agreement Richstone were authorised:

“To insure the said vessels their apparel fittings freight earnings and disbursements against the usual risks either with Lloyd’s or with insurance associations and to enter the said vessels in protection or indemnity or kindred associations and to make such claims as become necessary thereunder.” So there can be no doubt that Richstone had actual authority on behalf of Axelson to obtain insurance against claims by members of the crew, since this is one of the standard heads of cover under P. and I. insurance. On 1 January 1984 Part IV of the Employees’ Compensation (Amendment) Ordinance (No 76 of 1982) came into force, under which employers were obliged to insure themselves against claims from their employees. Axelson instructed Mr Pak to obtain the appropriate cover. Mr Pak approached the insurers. They sent him their standard form of “Proposal For Workmen’s Compensation Insurance.”… The proposal was signed by Richstone Industries Co Ltd. The signature is not qualified by the words “as agents” or by any other similar qualification. On 27 June 1983 the insurers issued a policy in their standard form. The name of the insured is given as “Messrs. Richstone Industries Co. Ltd.” and their business as “shipping.”…The policy was signed by Mr Tung himself on behalf of the insurers. As already mentioned, the judge found as a fact that Richstone had actual authority to effect the insurance on Axelson’s behalf. He also made certain other findings as to the insured state of knowledge, and in particular that they knew (i) that Richstone were shipping agents, not shipowners, (ii) that Richstone were not the owners of the Barquentine Osprey, and (iii) that Richstone had acted as agents of the owners of the Barquenfine Osprey in relation to the hull policy in 1981.

In the light of these findings, it could well have been argued that this was not a case of undisclosed principal at all, but rather a case in which Richstone was acting, and was known to be acting, on behalf of a disclosed but unnamed principal. For there was no finding that the insurers knew the name of the owners. However the judge made a further important finding in this connection. He said that he was not satisfied that the insurers knew that Richstone were not the employers of the crew. In the normal way, of course, it is the owners who employ the crew, not their agents. It is commonplace for the agents to engage the crew on behalf of the owners. Thus in the present case the master was engaged by Richstone and the crew were engaged by the master. But it is very rare for the agents to employ the crew. In declining to infer knowledge on the part of the insurers that the owners of the Barquentine Osprey were the employers of the crew, the judge may have been over generous to the insurers, especially as the insurers called no evidence. But in the light of that negative finding, their Lordships are obliged to approach the case on the same basis as the courts below, namely, that the plaintiffs can only succeed if they can show that Axelson were entitled to enforce the policy as undisclosed (as distinct from unnamed) principals. The main features of the law relating to an undisclosed principal have been settled since at least at the end of the 18th century. A hundred years later, in 1872, Blackburn J said in Armstrong v Stokes (1872) LR 7 QB 598, 604 that it had often been doubted whether it was originally right to hold that an undisclosed principal was liable to be sued on the contract made by an agent on his behalf, but added that “doubts of this kind come now too late.” For present purposes the law can be summarised shortly. (1) An undisclosed principal may sue and be sued on a contract made by an agent on his behalf, acting within the scope of his actual authority. (2) In entering into the

contract, the agent must intend to act on the principal’s behalf. (3) The agent of an undisclosed principal may also sue and be sued on the contract. (4) Any defence which the third party may have against the agent is available against his principal. (5) The terms of the contract may, expressly or by implication, exclude the principals right to sue, and his liability to be sued. The contract itself, or the circumstances surrounding the contract, may show that the agent is the true and only principal. The origin of, and theoretical justification for, the doctrine of the undisclosed principal has been the subject of much discussion by academic writers. Their Lordships would especially mention the influential article by Goodhart and Hamson, “Undisclosed Principals in Contract” (1932) 4 CLJ 320, commenting on the then recent case of Collins v Associated Greyhound Racecourses Ltd [1930] 1 Ch 1. It seems to be generally accepted that, while the development of this branch of the law may have been anomalous, since it runs counter to fundamental principles of privity of contract, it is justified on grounds of commercial convenience. The present case is concerned with the fifth of the features noted above. The law in that connection was stated by Diplock LJ in Teheran-Europe Co Ltd v S T Belton (Tractors) Ltd [1968] 2 QB 545, 555: “Where an agent has…actual authority and enters into a contract with another party intending to do so on behalf of his principal, it matters not whether he discloses to the other party the identity of his principal, or even that, he is contracting on behalf of a principal at all, if the other party is willing or leads the agent to believe that he is willing to treat as a party to the contract anyone on whose behalf the agent may have been authorised to contract In the case of an ordinary commercial contract such willingness of the other party may be assumed by the agent unless either the other party manifests his unwillingness or there are other

circumstances which should lead the agent to realise that the other party was not so willing.” Since the contract in the present case is an ordinary commercial contract, Axelson were entitled to sue as undisclosed principal unless Richstone should have realised that the insurers were unwilling to contract with anyone other than themselves. In the courts below Keith J at first instance, and the majority of the Court of Appeal held that the language of the proposal form and of the policy was inconsistent with the insured being anyone other than Richstone…Litton JA dissented. He held that the language of the proposal form was not such as to exclude the right of Axelson to sue as undisclosed principal. He drew attention to question 3(a), in which the insurers asked: “Have you any circular saws or other machinery driven by steam, gas, water, electricity or other mechanical power?” The answer was: “One 320 b.h.p.diesel engine; two 40 b.h.p. diesel generators.” This answer could only refer to the Barquentne Osprey. It could not possibly refer to Richstone, since Richstone were not ship owners. It follows that “you” in question 3(a) could not refer to Richstone personally. It must refer to the owners of the Barquentine Osprey…On this point their Lordships find themselves in full agreement with the dissenting judgment of Litton JA True, the proposal form is directed to Richstone as proposer. But nowhere does it state, or imply, that Richstone might not propose insurance on behalf of others. Nowhere in the proposal form is the question asked “Who is the employer?” Nor, having regard to Richstone’s answers, were the insurers entitled to assume, as Keith J held, that Richstone were the employers. But their Lordships go further. Even if Richstone had been named as employer, expressly or by implication, it would not necessarily have prevented Axelson intervening to show that they were the true principals. This was the point decided in Fred. Drughorn Ltd v Rederiaktiebolaget

Transatlantic [1919] AC 203. In that case a charter-party was signed on behalf of an individual who was named as the charterer. It was held by the House of Lords that this was not inconsistent with the named charterer having entered into the charterparty as agent for his employer. Accordingly the employer was entitled to intervene as undisclosed principal, and enforce the charterparty against the owners. The same reasoning would have applied in the present case if Richstone had been named as employer. If courts are too ready to construe written contracts as contradicting the right of an undisclosed principal to intervene, it would go far to destroy the beneficial assumption in commercial cases, to which Diplock J referred in Teheran-Europe Co Ltd v ST Belton (Tractors) Ltd [above]… Finally, under this head, the insurers relied on the concluding paragraph in the proposal form, whereby Richstone declared that all statements in the proposal form were true, and further agreed that such declaration should form the basis of the contract. But if, on its true construction, “you” and “your “ in the proposal form should be read as meaning, or at any rate including, the owners of the Barquentine Osprey, then the declaration adds nothing. Their Lordships would therefore hold that there is nothing in the terms of the proposal form, or the policy, which expressly or by implication excludes Axelson’s right to sue as undisclosed principal. But Mr Thomas, on behalf of the insurers, has a further argument. He submits that a contract of insurance is a contract of a special kind. It is a personal contract, which of its nature is inconsistent with intervention by an undisclosed principal. This argument is described as a subsidiary argument in the insurers’ case. It was not mentioned in any of the judgments below. But it was given prominence by Mr Thomas in his submissions before the Board. If it is correct, it would have very far reaching consequences. The starting point of the argument is the article by Goodhart and Hamson, where it is suggested, 4

CLJ 320, 323, that the doctrine of undisclosed principal bears some resemblance to the assignment of contractual rights. This analogy has been developed by subsequent writers: see Bowstead on Agency, 115th edn (1985), p 321, Chitty on Contracts, 26th edn (1989), vol 2, p 42, para 2552, and Powell on the Law of Agency, 2nd edn (1961), p 165. Mr Thomas contends that, if the contract is one that cannot be assigned, because it is “personal” by nature, neither should it be capable of being enforced by an undisclosed principal. Contracts of insurance are of this kind. Thus according to MacGillivray and Parkington on Insurance Law, 8th edn (1988), p 717, para 1616: “A contract of insurance is a personal contract and does not run with the property which is the subject matter of the insurance.” Mr Thomas relied on Peters v General Accident Fire & Life Assurance Corporation Ltd. [1937] 4 All ER 628. That was a case of motor insurance. Goddard J held that the policy was a contract of personal indemnity, and could not be assigned to a purchaser. His decision was upheld by the Court of Appeal [1938] 2 All ER 267. By the same token, so it was argued, an employees liability policy is a contract of personal indemnity. It cannot be assigned. It follows that it cannot be made on behalf of an undisclosed principal. The insurer is always entitled to know of the existence and identity of the assured. Richstone should have realised, in the words of Diplock LJ [1968] 2 QB 545, 555, that the insurers would not have been willing to treat anyone other than Richstone as a party to the contract. Mr Thomas accepted that in marine insurance the rule is different. But this was not, he said, a case of marine insurance. The short answer to Mr Thomas’s argument lies in a finding by the judge that the actual identity of the employer was a matter of indifference. It was not material to the risk. “Eastern would have been content” he said “to insure the employer of the crew of the Barquenfine Osprey, whoever it was, provided that it was satisfied with the answers given in

boxes 6 and 7 of the proposal form.” [Question 6 required details of any current employers’ liability insurance, whether any such proposal had ever been declined, withdrawn or cancelled; and question 7 required details of employee salary costs. Both were left blank]. In the light of that finding it is impossible for the insurers to contend that this was a “personal” contract of the kind that excludes the rights of an undisclosed principal. In passing it may be noticed that the insurers seem to have been content to insure the employers, even though they received no answer to questions 6 and 7. Although this short answer is sufficient to dispose of Mr Thomas’s argument, it would not be right to leave the matter there. Their Lordships accept that there is a class of personal contract where the burden cannot be performed vicariously. The example often given is a contract to paint a portrait. Such a contract cannot be enforced by an undisclosed principal since, as Goodhart and Hamson point out, his intervention in such a case would be a breach of the very contract in which he seeks to intervene. But their Lordships are unwilling to accept that a contract of indemnity insurance is a personal contract in that sense. No case was cited to their Lordships which decides, or even suggests, that a contract of insurance is an exception to the general rule that an undisclosed principal may sue on a contract made by an agent within his actual authority…’

Note: In National Oilwell (below, [1125]) Colman J (disapproving the decision of Hamilton J in Grover & Grover Ltd v Mathews [1910] 2 KB 401), expressed the view that a third party should be able to ratify a policy with knowledge of an insured loss (as is the case in marine insurance).

[1125] National Oilwell Ltd v Davy Offshore (UK) Ltd [1993] 2 Lloyd’s Rep 582 [see [1212]] Colman J: [summarised the authorities thus] ‘(1) Where at the time when the contract of insurance was made the principal assured or other contracting party had express or implied actual authority to enter into that contract so as to bind some other party as co-assured and intended so to bind that party, the latter may sue on the policy as the undisclosed principal and co-assured regardless of whether the policy described a class of coassured of which he was or became a member. (2) Where at the time when the contract of insurance was made the principal assured or other contracting party had no actual authority to bind the other party to the contract of insurance, but the policy is expressed to insure not only the principal assured but also a class of others who are not identified in that policy, a party who at the time when the policy was effected could have been ascertained to qualify as a member of that class can ratify and sue on the policy as co-assured if at that time it was intended by the principal assured or other contracting party to create privity of contract with the insurers on behalf of that particular party. Evidence as to whether in any particular case the principal assured or other contracting party did have the requisite intention may be provided by the terms of the policy itself, by the terms of any contract between the principal assured or other contracting party and the alleged co-assured or by any other admissible material showing what was subjectively intended by the principal assured… It therefore follows that in the present case NOW can establish privity of contract with the insurers by one of two routes: by establishing either that they were undisclosed or

unnamed principals of DOL or that they were entitled to and did ratify the policy. In both cases it is necessary for them to establish that at the time of effecting the policy DOL intended to effect insurance cover on behalf of NOW. Did DOL have authority to bind NOW to the Policy, to the extent contended for by NOW? The most obvious source of authority is the agreement. Clause 14.2…imposed on DOL an obligation to effect insurance of the work. As a matter of construction there must be a strong inference that DOL’s authority to insure was co-extensive with its obligation to do so. What was the extent of its obligation? The wording of clause 14.2 is obscure, particularly because the word “Work” is contractually defined in clause 1 of the agreement as: …all or any plant machinery materials or equipment to be manufactured and supplied or services and/or personnel to be provided by the Supplier under the contract. Mr Falconer [counsel for the claimants, NOW] submits that “all sub-contractors” refers to all DOL’s and NOW’s subcontractors. I do not agree. This being a contract entered into by the head contractor with a supplier as subcontractor, in a standard form, there is no obvious commercial reason why the head contractor should undertake or the sub-contractor require the head contractor to undertake to effect insurance for other sub-contractors of the head contractor and every commercial reason why the head contractor should undertake and why the subcontractor should require him to undertake to effect insurance cover for the sub-contractors of the subcontractor… Such authority as there is suggests that the party seeking to rely on the policy could not ratify it after he became aware of the loss. In Williams v North China Insurance Co, (1876) 1 CPD 757 the Divisional Court of the Common Pleas

Division (Cockburn, CJ, Jessel, MR, Lord Justice Mellish and Baron Pollock) upheld the rule in marine insurance that there could be ratification after a known loss as being already settled law and consistent with commercial convenience, but treated this as an exemption to the general principle that one who ratifies a contract must have power to make it at the time of ratification…: if it was impossible to ratify a contract to sell goods which at the time of ratification had already perished, it was equally impossible to ratify an insurance on goods which were known at the time of ratification to have already perished. In Grover & Grover Ltd v Mathews [1910] 2 KB 401 Mr Justice Hamilton held in relation to a fire policy that ratification was impermissible with knowledge of a loss. In the much earlier decision in Waters v Monarch Fire and Life Assurance Co, [above, [622]]…Lord Campbell, CJ in the last sentence of his judgment said this: “The authorities are clear that an assurance made without orders may be ratified by the owners of the property, and then the assurers become trustees for them.” He there seems to contemplate ratification after loss, but the analysis of the bailee’s right to sue which Lord Campbell appears to put forward does not reflect what is now the law on the position of the unauthorized bailee who insures goods in his possession. Where the bailee sues on the policy ratification is quite irrelevant. His ability to recover the whole value of the goods arises from his own interest and arises independently of assent on the part of the true owner…Therefore, no weight can be attached to this dictum. It is suggested in MacGillivray & Parkington, Insurance Law, 8th edn, para. 370 that the ability to ratify should not depend on the state of mind of the ratifying party at the date of the purported ratification: he must merely have had capacity at the time when the contract was made in his

name. The Canadian, American and Australian Courts have all permitted ratification of non-marine policies after the loss has occurred to the knowledge of the ratifying party. I can see neither legal principle nor commercial reason why the English Courts should not take the same approach. A rule which has worked perfectly well for over a century for marine insurance can be expected to work equally well for non-marine. It is undesirable that different rules should apply to the two classes of insurance and that in the absence of binding or compelling authority to the contrary the English Courts should take a different view on a question of principle in insurance law from the views already established in other common law jurisdictions. Accordingly had it been necessary for my decision in this case, I would not have followed Grover & Grover v Mathews or the dicta in Williams v North China Insurance Co. and would have held that NOW could ratify with knowledge of an insured loss, notwithstanding the policy was non-marine.’

11.4 Third Party Rights Against Insurers As has been seen, it is an axiom of English law that no one can sue under a contract to which they are not a party (Dunlop Pnuematic Tyre Co Ltd v Selfridge & Co Ltd [1915] AC 847). This means that a person injured by the negligence of another, who has an insurance policy that covers the liability, must sue the tortfeasor, who must, in turn, claim under the liability policy. As commented above, in practice, the impact of the Contracts (Rights of Third Parties) Act 1999 [1122] on the privity rule in insurance may be reduced since insurers are likely to exclude its

application (under section 1(2)). However, a number of statutes have improved the rights of third parties. [1126] Law Reform Commission of British Columbia, Minor Report on the Insurance Act s 26(1) (LRC 125, 1992) ‘There are two different perspectives on the function third party liability insurance performs. The first function is to protect the policyholder against the risk of loss. If the policyholder who causes loss satisfies the victim’s claim, the insured is reimbursed or indemnified by the insurer (subject to the terms of the policy). Historically, this was looked upon as the sole function of third party liability insurance. In other cases, particularly those involving large claims, in the absence of the policy there simply would be no compensation to the victim. As a result, the second function served by insurance is to make sure there are adequate funds to satisfy third party liability. Insurance is a matter of contract between the insurer and the insured and, at common law, an injured person had no direct claim against the insurer. If the insured declined to call upon the insurer, a victim who could not satisfy the judgment from the wrongdoer’s property remained uncompensated. This might happen, for example, where the insured became insolvent, or left the province to avoid creditors.’

11.4.1 Third Parties (Rights Against Insurers) Act 1930 The wish to resolve injustices caused by the privity rule has sometimes outweighed the wish to maintain

the rule. The Third Parties (Rights Against Insurers) Act 1930 enabled third parties to claim directly against insurers where the insured had become insolvent. The need for this statute emerged from a reluctant decision by the Court of Appeal in Re Harrington Motor Co Ltd, ex parte Chaplin [1928] Ch 105 (CA). Mr Chaplin was knocked down by a taxi owned by the company and recovered judgment, but a stay of execution was granted to enable an appeal. Before the stay expired, the company went into liquidation. The company’s motor policy promised that the insurers would reimburse all sums for which the insured was liable and they paid to the liquidator the amount of the judgment awarded to Mr Chaplin. This went into the general funds available for all the company’s creditors. The Court of Appeal held Mr Chaplin did not have a direct claim against the insurers. Atkin LJ regretted the decision: ‘the applicant has a real grievance, and if it were possible to decide for him I should very willingly do so.’ He continued: ‘It obviously would disturb the whole practice of insurance if the claimant against the assured who caused the risk had a direct right of recourse against the insurance company, and we know that in actual practice the assured receives the money — the parties being solvent — and does not pay over necessarily that sum of money to the third party who is injured, but, of course, pays his claim out of his own assets and uses the insurance money, so far as it goes, because it does not always completely meet his liability.’

In Hood’s Trustees v Southern Union General Insurance Co of Australasia Ltd [1928] Ch 793, Caddy, the injured party, was not even allowed to participate with other creditors in the bankruptcy because he had not established his claim before the bankruptcy. Caddy, therefore, obtained a second order of adjudication in bankruptcy against Hood, but this placed him in no better position since the courts ruled that the insurance moneys were payable to the trustees of the first bankruptcy. This meant that the creditors received something of a windfall in which the person whose injury brought that windfall was not allowed to share. For a similar decision in New Zealand, see Smith v Horlor [1930] NZLR 530. Third parties had a right to sue insurers direct in the event of the insured’s insolvency under the Workmen’s Compensation Act 1897, section 5, but it was only with the clamour that followed cases like Re Harrington that a general right was established through the 1930 Act ((1929-30) 231 Hansard: Commons 128–30, Sir William Jowitt). Legislation similar to this Act appeared in other Commonwealth jurisdictions: New Zealand enacted a limited form, which applied to motor accidents, as early as 1928 (discussed in Law Commission, Some Insurance Law Problems, Report 46 (Wellington, New Zealand, 1998); this report also refers to the legislation in Australia. See also, Singapore’s Third Parties (Rights against Insurers) Act (c. 395)). The injustice of the outcome in Hood’s Trustees seems clear, but it is less obvious why a creditor should gain preference over other creditors, such as

an unpaid seller of goods, particularly since, with a handful of exceptions where insurance is compulsory, it is a matter of chance that the tortfeasor has taken out liability insurance and without it the victim would be no better off than other creditors. ‘The money which is being received and which will be distributed by the liquidator is a sum which the debtors, the company, have secured should be paid to them in certain events, but which has been secured by their own contract made with the insurance company, and not by any intervention of the creditor, Mr Chaplin, although it was in consequence of an accident which he suffered that the loss arose, in respect of which the insurance company has made the payment.’ (Re Harrington Motor Co, ex parte Chaplin [1928] Ch 105, Lord Hanworth MR)

11.4.2 Construing the 1930 Act A third party is not obliged to take the route offered by the Act. The option to sue the insured remains, in which case the insured is left to seek reimbursement under the policy. It is also worth emphasising that transfer of the insured’s rights to the third party only takes place on the occurrence of one of the events in section 1(1)). In Tarbuck v Avon Insurance plc [2002] QB 571, it was held that the words ‘liabilities to third parties which he may incur’ (s 1) refer only to liabilities imposed on an insured by operation of law for breach of contract or in tort; they do not include liabilities voluntarily undertaken. So, a solicitor could not claim legal expenses under a client’s legal

expenses insurance when that client became bankrupt. See Law Commission, Third Parties (Rights Against Insurers) Act 1930: Report, consultation paper 152 (London: HMSO, 2001), which provides a valuable overview of both the Act and the criticisms that have been made of its interpretation and operation. (a) Where liability is not established before insolvency: [1127] Post Office v Norwich Union Fire Insurance Society Ltd [1967] 2 QB 363 (CA) [Contractors, who were insured under a public liability policy, damaged a Post Office cable and the Post Office by letter claimed for its repair, but the contractors denied liability and before proceedings had begun to determine liability and quantum, the contractors went into compulsory liquidation. The Post Office proceeded against the insurers under the 1930 Act. The insurers, however, claimed that until liability and quantum had been determined, the Post Office had no cause of action against the insurers under the policy. The Court of Appeal held for the insurers.] Lord Denning, MR: ‘Under that section [section 1(1)] the injured person steps into the shoes of the wrongdoer. There are transferred to him the wrongdoer’s “rights against the insurers under the contract.” What are those rights? When do they arise? So far as the “liability” of the insured is concerned, there is no

doubt that his liability to the injured person arises at the time of the accident, when negligence and damage coincide. But the “rights” of the insured person against the insurers do not arise at that time. The policy says that “the company will indemnify the insured against all sums which the insured shall become legally liable to pay as compensation in respect of loss of or damage to property.” It seems to me that the insured only acquires a right to sue for the money when his liability to the injured person has been established so as to give rise to a right of indemnity. His liability to the injured person must be ascertained and determined to exist, either by judgment of the court or by an award in arbitration or by agreement. Until that is done, the right to an indemnity does not arise. I agree with the statement by Devlin J in West Wake Price & Co v Ching [1957] 1 WLR 45, 49 “The assured cannot recover anything under the main indemnity clause or make any claim against the underwriters until they have been found liable and so sustained a loss.” Under the section it is clear to me that the injured person cannot sue the insurance company except in such circumstances as the insured himself could have sued the insurance company. The insured could only have sued for an indemnity when his liability to the third person was established and the amount of the loss ascertained. In some circumstances the insured might sue earlier for a declaration, for example, if the insured company were repudiating the policy for some reason. But where the policy is admittedly good, the insured cannot sue for an indemnity until his own liability to the third person is ascertained… …This is simply a matter of procedure. I think the right procedure is for the injured person to sue the wrongdoer, and having got judgment against the wrongdoer, then make his claim against the insurance company. This attempt to sue the insurance company direct (before liability is established) is not correct.’

Notes: 1. This decision was affirmed by the House of Lords in Bradley v Eagle Star Insurance Co Ltd [1989] AC 957. Mrs Bradley, who had been employed in a cotton mill between 1933 and 1970, was certified to be suffering from byssinosis, a respiratory disease caused by the inhalation of cotton dust, however, the cotton mill company had been wound up before Mrs Bradley commenced her action. The House of Lords held that the insured could not sue for an indemnity from the insurers until the existence and amount of the liability to a third party had been established, and since the dissolution of the company made it impossible to establish the existence and amount of any liability to the applicant, there was no right of indemnity that could be transferred to Bradley under section 1(1) of the Act. Lord Templeman dissented from the majority: ‘The 1930 Act was intended to protect a person who suffers an insured loss at the hands of a company which goes into liquidation. That protection was afforded by transferring the benefit of the insurance policy from the company to the injured person. In my opinion, Parliament cannot have intended that the protection afforded against a company in liquidation should cease as soon as the company in liquidation reaches its predestined and inevitable determination in the dissolution of the company.’

The case led to the amendment of the Companies Act 1985 (by the Companies Act

1989, s 141). Under section 651, where a company has been dissolved, the court can make an order declaring the dissolution void and proceedings may be taken as if the company had not been dissolved. The operation of this amendment was made retrospective so that Mrs Bradley’s claim could proceed. By section 141(4) Companies Act 1989, applications cannot be made to restore a company dissolved more than 20 years before the commencement of the section (ie 16 November 1989). 2. It was held (albeit for different reasons) in Nigel Upchurch Associates v Aldridge Estates Investment Co Ltd [1993] 1 Lloyd’s Rep 535 and Woolwich Building Society v Taylor [1995] 1 BCLC 132 that a third party cannot apply for information about insurance under section 2 of the 1930 Act until liability has been established, even though it seems from the debates on the bill during its passage through parliament the intention had been that pre-trial disclosure of information would be facilitated by the Act: Law Commission, Third Parties (Rights Against Insurers) Act 1930: Report, consultation paper 152 (2001), 4.18. This means, in the words of the Law Commission, ‘Third parties are already placed at a disadvantage by their inability to meet certain policy conditions which can only be fulfilled by the insured. They have been further disadvantaged by the court’s interpretation of section 2 as they may not

learn of the policy conditions which they could, in theory, have met until it is too late.’ (5.68) (b) Where a term of the policy was not fulfilled: Under the 1930 Act, any term is invalid as against a third party if it purports to render the policy void in the event of insolvency (section 1(3)). However, other conditions precedent to liability can be used to deny liability, even though — as is likely to be the case — the third party is unaware of their existence. In Farrell v Federated Employers’ Insurance Association Ltd [1970] 2 Lloyd’s Rep 170 (CA), Mr Farrell was injured in the course of his employment and was told by his employer’s insurers to send a proposed writ to the employer. Before this was done, the employer went into liquidation. The action was then commenced and damages awarded. The judgment was not satisfied by the employers, so an action was brought under the 1930 Act against the insurers. They rejected the claim on the ground that there had been a breach of a policy condition, namely, that every writ served on the employer had to be notified to the insurers immediately on receipt and that this was a condition precedent to the insurers’ liability. The Court of Appeal upheld the decision of Mackenna J that the condition applied and since there had not been immediate notification the insurers could resist the claim, even if they were not prejudiced by the failure to notify. Lord Denning MR said, ‘The injured person is here claiming the benefit of a policy which is issued to the employers. He must take it as he finds it. He

cannot claim the advantages and reject the disadvantages. He cannot claim the benefit and reject the conditions of it’. This decision was overturned by the Employers’ Liability (Compulsory Insurance) General Regulations 1971/1117, regulation 2 (amending the Employers’ Liability (Compulsory Insurance) Act) (11.32). However, the principle in Farrell still holds good for the interpretation of the 1930 Act. [1128] Firma C–Trade SA v Newcastle Protection and Indemnity Association [1991] 2 AC 1 (HL) [The case involved two appeals concerning claims by members of P & I (Protection and Indemnity) clubs for losses. Such clubs are mutual associations whereby the members as a whole agree to recompense those members who suffer loss, so that each member is an insurer and an insured. The rules of these clubs oblige them to indemnify members in respect of claims that come within the rules and that they are liable to pay and have paid (‘pay to be paid’ clause). Where a member was liable but had not settled before going into liquidation, the House of Lords took the view that the clause did not breach section 1(3), and the club was not liable under the 1930 Act because the pay to be paid clause was a condition precedent to the club’s liability. The Act only transferred such rights as the insured had, so the third party could not have a better right against the club than the member, and a member who had not

paid out on a claim would have had no right against the club.] Lord Brandon: ‘…it was contended for the third parties that section 1(3) of the Act of 1930 rendered the “pay to be paid” provisions in the clubs’ rules of no effect, on the ground that they purported, directly or indirectly, to alter the rights of the parties under their contracts of insurance upon the members being ordered to be wound up. There are, in my view, substantial difficulties in the way of this contention. The “pay to be paid” provisions applied throughout the lives of the contracts of insurance made between the members and the clubs, imposing a condition necessary to be fulfilled before any liability of the clubs to indemnify the members could arise. They were not provisions which only applied upon the happening of a specified event such as an order for the winding up of a member. They applied equally before and after such an event. It is no doubt true that, upon any member being ordered to be wound up because of insolvency, that member would be likely to be prevented from discharging any liability to a third party which he had incurred and so be unable to obtain an indemnity from his club in respect of it. This situation, however, does not result, directly or indirectly, from any alteration of the member’s rights under his contract of insurance. It results rather from the member’s inability, by reason of insolvency, to exercise those rights. …The effect of these provisions [sections 1(1) and 1(4)] is that, in a case where the insurer would have had a good defence to a claim made by the insured before the statutory transfer of his rights to the third party, the insurer will have precisely the same good defence to a claim made by the third party after such transfer. In the two present cases it is not in doubt that the clubs would have had good defences

to any claims to an indemnity made by the members before they were ordered to be wound up, on the ground that the condition precedent to their rights to such indemnity, namely, the prior discharge by the members of their liabilities to the third parties, had not been satisfied. It must follow that the clubs had the same good defences to claims for an indemnity made by the third parties after the members were ordered to be wound up.’

Lord Goff: [dealing with the argument that because clubs sometimes paid third parties direct without requiring the member to have paid this indicated that the proper construction of the rule was that it is the club which is obliged to indemnify the third party direct] ‘First, it appears to me that the club’s payment does not at the same time operate to fulfil the condition of prior payment. On the contrary the club, by paying the third party direct and so discharging the member’s liability to the third party, indemnifies the member against that liability although he has not fulfilled the condition of prior payment; accordingly the club, by so doing, waives the requirement that the member should first have paid the third party. Second, even if it were the case that the club’s payment did operate to fulfil the condition of prior payment, the most that can be drawn from this fact is that it may be consistent with the rules that the club may, if it wishes, pay the third party direct and so fulfil the condition of prior payment. I can see no basis for concluding that, as a matter of construction of the rules, the club is under any obligation to indemnify the member by paying the third party direct. …It is evident that certain of the judges in the courts below…were much affected by what they perceived to be the unfortunate consequences which would follow if the cargo owners were denied a direct action against the clubs. Indeed, Stuart-Smith LJ went so far as to say that, if the

argument of the clubs were to prevail, any liability insurer could drive a coach and horses through the Act by the simple device of incorporating a pay to be paid clause in the policy. To my mind, this statement both exaggerates the danger and ignores the policy underlying the Act of 1930. In his judgment, Bingham LJ…summarised in eight points his general approach to the construction of the Act. With that admirable summary, I respectfully agree. In it, he stressed that the primary purpose of the Act was to remedy the injustice highlighted in particular in In re Harrington Motor Co Ltd, Ex parte Chaplin, in which it was held that payment by an insurance company to an insolvent insured of a sum due under a liability policy, fell to be distributed among the creditors of the insured, of whom the injured party was only one: see Bradley v Eagle Star Insurance Co Ltd…per Lord Brandon of Oakbrook. He also stressed that under the Act there were to be transferred to the third party only such rights as the insured had under the contract of insurance, subject always to section 1(3) of the Act which in effect prevented contracting out of the statutory transfer. This being the statutory scheme, it is very difficult to see how it could be said that a condition of prior payment would drive a coach and horses through the Act; for the Act was not directed to giving the third party greater rights than the insured had under the contract of insurance. But it is also necessary to observe that, in contrast to, for example, employers and motorists, Parliament has not generally required (apart from special cases, such as the Merchant Shipping Act 1995) that shipowners should be compulsorily insured against liability to third parties. Where Parliament does require compulsory insurance, it generally provides in the relevant legislation that clauses in the contract of insurance which defeat the purpose of such insurance will be ineffective (see, eg, sections 148 to 150 of the Road Traffic Act 1988 (11.35), and regulation 2 of the Employers’ Liability (Compulsory Insurance) General Regulations 1971

(SI 1971 No. 1117), made pursuant to the Employers’ Liability (Compulsory Insurance) Act 1969: [1132]. This however is not the general rule in the case of shipowners’ liability to third parties. Indeed, so far as cargo owners are concerned, it is of course well known that cargo is ordinarily insured with cargo underwriters, so that no doubt in the present cases the battle was effectively fought between two groups of insurers. There may conceivably be cases in which there is loss of life or personal injury, arising from default on the part of shipowners or their employees, in which insolvency of the shipowners could have the effect that a P & I Club in which the relevant ship was entered could, in theory, decline to make payment direct to the injured party or his next of kin. Your Lordships were informed that, in such a case, the directors of one, if not both, of the clubs in the present litigation waive the condition of prior payment; indeed, it is not to be forgotten that the directors of P & I Clubs are themselves shipowners, who are capable of having regard to the wider interests of their industry. Not a single example was given to your Lordships of an individual claimant in such a case being defeated by a club invoking the condition of prior payment. Manifestly, P & I Clubs did not incorporate the condition of prior payment in their rules for the purpose of defeating the application of the Act of 1930, since the condition was a regular feature of P & I Club rules long before 1930. Moreover, it seems highly unlikely that other liability insurers would (if they were free to do so) incorporate any such condition in their policies for that purpose, because to do so would be likely to render their insurance policies less marketable in a competitive world. In all the circumstances, therefore, I do not consider that the decision of your Lordships’ House in the present cases is likely to lead to adverse consequences of the kind feared by Staughton J and Stuart-Smith LJ No doubt those responsible for legislation in this field will in any event be monitoring the

position, and they can, if there proves to be any practical need for it, promote the appropriate remedial legislation.’

(c) Can liabilities of the insured to the insurer be set off? [1129] Murray v Legal and General Assurance Society Ltd [1970] 2 QB 425 [Murray claimed against his employers for injuries suffered at work due to their negligence. The claim was passed to the employers’ insurers, and they proposed to set off against any claim the premium owing on the policy. Before judgment the employers went into voluntary liquidation and Murray then proceeded against the insurers, who sought to set off the premium.] Cummings-Bruce J: ‘…did the Act merely put the plaintiff into the shoes of the insured, so as to transfer to the third party the whole bundle of the rights of the insured, subject to the whole bundle of his liabilities under the contract of insurance, or did Parliament give to the third party the privileged position of asserting the rights of the insured in respect of his liability to the plaintiff and of disregarding the liabilities of the insured to the insurers, for example, in respect of unpaid premiums? What effect must be given to the words “in respect of the liability” which appear in the section? In my view, those words are of the utmost importance. It is not all the rights and liabilities of the insured under the contract of insurance which are transferred to the third party, only the particular rights in respect of the liability

incurred by the insured to the third party. When one looks at subsection (4) one finds the following language: “Upon a transfer under subsection (1) or subsection (2) of this section the insurer shall, subject to the provisions of section 3 of this Act be under the same liability to the third party as he would have been under to the insured, but…” and then follows (a) and (b) which deal with the differences between the liability of the insurers to the insured and the liability of the insured to the third party; this shows that the draftsman in that subsection was addressing his mind to problems that arise in connection with the liability of the insurers to the insured in relation to the particular liability of the insured to the third party. In my view this section had a carefully limited intention. There is no express transfer of liabilities of the insured to the insurers…but if there is, under the policy, a defence by way of condition available against the insured, that defence would be available against the third party. In my view, in the words used to create the statutory subrogation, the draftsman did carefully limit the subrogation to the rights under the contract in respect of the liability incurred by the insured to the third party. Rights which are not referable to the particular liability of the insured to the particular third party are not transferred. Thus all the conditions in the policy which modify or control the obligations of the insurers to cover a given liability to a third party are the subject of transfer…The right to recovery of the premiums in this case was not a term of the policy which arose in respect of the liability of the insured to the third party. The defendants are in my view left in regard thereto with the same rights as the general body of creditors, namely, to prove in the bankruptcy. It follows that the plaintiff is entitled to judgment.’

Note: In Hartford Insurance Co (Singapore) Ltd) v Chiu Teng Construction Pte Ltd [2002] 1 SLR 278 (Court of Appeal, Singapore), C sued B for a loss caused by negligence, but before the action came to court B went into liquidation. C then obtained judgment for damages. H, B’s insurer, had been informed of the action but decided not to intervene because it did not consider itself liable under the policy. C then sued H under the Singapore version of the English statute. H wished to challenge the quantum of the loss on the ground that it was not binding on H. The Court of Appeal in Singapore held that the winding up of B enabled C to step into the company’s shoes and the right to be indemnified was transferred to C. It was not open to H, who had been aware of the previous action, to reopen the issue of quantum of loss. (d) Rights of third parties against insurers overseas: In some jurisdictions, such as Spain, a third party claimant is always entitled to sue the insurers directly and the insurers can only avoid liability in relatively limited circumstances, such as, where the claim concerns a risk that is not covered by the policy. The insurers cannot avoid liability on the grounds of some act or omission of the insured, such as a misrepresentation or a failure to give notice of a claim, although they retain the right to claim against the insured with respect to such matters. Many

Commonwealth jurisdictions have adopted the English approach (eg Singapore’s Third Parties (Rights against Insurers) Act (c 395)), others have chosen to expand the rights of third parties. [1130] Insurance Australia)

Contracts

Act

1984

(Cth,

‘section 51 (1) Where: (a) the insured under a contract of liability insurance is liable in damages to a person (in this section called the third party); (b) the insured has died or cannot, after reasonable enquiry, be found; and (c) the contract provides insurance cover in respect of the liability; the third party may recover from the insurer an amount equal to the insurer’s liability under the contract in respect of the insured’s liability in damages. (2) A payment under subsection (1) is a discharge, to the extent of the payment, in respect of: (a) the insurer’s liability under the contract; and (b) the liability of the insured or of the insured’s legal personal representative to the third party.’

[1131] Insurance Act 1996 (British Columbia) ‘section 24 (1) If a judgment has been granted against a person in respect of a liability against which the person is insured and the judgment has not been satisfied, the judgment

creditor may recover by action against the insurer the lesser of (a) the unpaid amount of the judgment, and (b) the amount that the insurer would have been liable under the policy to pay to the insured had the insured satisfied the judgment. (2) The claim of a judgment creditor against an insurer under subsection (1) is subject to the same equities as would apply in favour of the insurer had the judgment been satisfied by the insured.’

Note: The predecessor to the provision in section 24 allowed recovery directly against insurers, ‘Where a person incurs liability for injury or damage to the person or property of another, and is insured against that liability’. So, there was no direct claim where a person suffered pure economic loss as a result of a professional person’s negligence (Starr Schein Enterprises Inc v Gestas Corporation Ltd., (1987) 13 BCLR (2d) 85 (BCCA)), or where the family dependents of someone wrongfully killed by another claimed under a statutory provision for the loss of support (Scurfield v Assitalia-Le Assicurazioni D’Italia SPA, [1992] BCJ No. 759 (BCSC)). See Law Reform Commission of British Columbia, Minor Report on the Insurance Act s 26(1) (LRC 125, 1992).

11.4.3 Reform of the 1930 Act in England

The Law Commission Law in Third Parties (Rights Against Insurers) Act 1930: Report, consultation paper 152 (London: HMSO, 2001), proposed reducing the procedural burdens placed on third parties by allowing them to issue proceedings against an insurer without first establishing the existence of the insured’s liability. The third party would not be required to proceed against the insured so there would be no need to restore a dissolved company to the register, which has been a serious hurdle for claimants. The Commission also proposed that third parties be able to obtain information about any rights transferred to them in order to enable a decision to be taken on whether to continue litigation or not without having to establish the insured’s liability. The Commission further suggested the removal of certain burdens imposed on third parties by technical defences. For instance, under the existing law a claim may fail because the insurer has a defence that the insured failed to give notice of the claim, even where the third party had told the insurer of the claim within the prescribed period; the proposal would not allow the insurer in such a situation to raise this defence. Similarly, the third party’s rights are worthless where the insurance contract makes it a precondition of the insurer’s liability that the insured has paid the claim (see The Fanti and The Padre Island [1991] 2 AC 1 (HL)). Here the Commission proposed that the third party would not be adversely affected by such a clause. The Commission also noted that the decision in Tarbuck v Avon Insurance plc [2002] QB 571, which prevented a solicitor with unpaid fees from claiming

directly on the legal expenses insurance of an insolvent client, would also apply to health and car repairs insurance policies. It was, therefore, proposed that a third party should be allowed a direct claim against an insurer even if the insurance covered liabilities to the third party that had been voluntarily incurred by the insured. These proposals were, along with others, accepted, and the government has expressed its intention to implement them through an order under the Regulatory Reform Act 2001.

11.4.4 Compulsory Liability Insurance In requiring parties to take out liability insurance, Parliament has discarded the freedom of people to choose whether or not to insure in favour of ensuring that third parties are compensated. It makes sense to facilitate this objective by allowing third parties to sue insurers direct, if only because it avoids the delays involved in claiming against an insured who, then, has to claim against the insurers. Although such schemes have not always initially addressed the problems posed by conditions precedent in policies, cases have commonly led to reform. For instance, the decision in Farrell v Federated Employers’ Insurance Association Ltd [1970] 2 Lloyd’s Rep 170 led to amendment of the Employers’ Liability (Compulsory Insurance) Act 1969. [1132] Employers’ Liability Insurance) General

(Compulsory Regulations

1971/1117, Regulation 2 ‘(1) Any condition in a policy of insurance issued or renewed in accordance with the requirements of the Act after the coming into operation of this Regulation which provides (in whatever terms) that no liability (either generally or in respect of a particular claim) shall arise under the policy, or that any such liability so arising shall cease — (a) in the event of some specified thing being done or omitted to be done after the happening of the event giving rise to a claim under the policy; (b) unless the policy holder takes reasonable care to protect his employees against the risk of bodily injury or disease in the course of their employment; (c) unless the policy holder complies with the requirements of any enactment for the protection of employees against the risk of bodily injury or disease in the course of their employment; and (d) unless the policy holder keeps specified records or provides the insurer with or makes available to him information therefrom, is hereby prohibited for the purposes of the Act. (2) Nothing in this Regulation shall be taken as prejudicing any provision in a policy requiring the policy holder to pay to the insurer any sums which the latter may have become liable to pay under the policy and which have been applied to the satisfaction of claims in respect of employees or any costs and expenses incurred in relation to such claims.’

Third party liability has been compulsory for motorists since 1930 (Road Traffic Act 1930), and the Act enabled third parties to sue insurers direct. However, the Act only rendered void as against the third party those conditions that related to some act

or omission after the accident. Otherwise, the third party had the same rights as the insured. [1133] Smith v Pearl Assurance Co Ltd [1939] 1 All ER 95 (CA) [Mr Smith, a passenger in a car driven by Mr Blackmore, was injured as a result of Blackmore’s negligence. Blackmore became bankrupt and Smith commenced an action against his insurers under the 1930 Act. However, the insurers sought to have the action stayed because there was an arbitration clause in the policy. The Court of Appeal stayed the action.] Slesser LJ: ‘The position of the present plaintiff, and that of Mr Blackmore, is made clear under the Act of 1930. Whatever his rights were, they are transferred to, and vested in, the plaintiff, and the result may be that, by reason of his poverty, the plaintiff who could have proceeded under the Poor Persons Rules may have difficulty in finding the money to proceed under the Arbitration Act. These facts cannot, in the circumstances, be any ground for saying that effect should not be given to the contract between Mr Blackmore and the insurance company when its rights and conditions are vested in the plaintiff.’ Clauson LJ: ‘It is pointed out that, if the matter is to go to arbitration, he will not get any corresponding benefit, and will be gravely hampered in establishing his case. This, it is to be observed, is a personal disability under which the plaintiff finds himself, a personal disability in no way connected with the

contractual rights or obligations arising out of the contract in respect of which he has, or conceives himself to have, a cause of action…I only wish to add that, should it become necessary in the future to deal further legislatively with the matter which was dealt with in the Third Parties (Rights against Insurers) Act 1930, I trust that those who have to deal with the matter will carefully consider whether there are not weighty reasons why persons who have the advantage of some such legislative provision should not be freed from the restriction, which might otherwise fall upon them, of being driven to arbitration. That, however, is a matter of policy, upon which I should not be justified in expressing any view. Nevertheless, I do think, having regard to such experience as I have had in these matters, that I am justified in drawing attention to the desirability of that question being very carefully considered, should the occasion arise.’

[1134] Austin v Zurich General Accident and Liability Insurance Company Limited [1945] KB 250 (CA) [The insurers issued a motor policy to Mr Aldridge, which covered anyone driving the car with his permission, although such drivers were subject to all the terms of the policy. The policy required any summons to be notified to the insurers immediately on receipt. While Mr Austin was driving the car, there was an accident that led to Aldridge’s death. The insurers successfully denied liability on the ground of a breach of the condition because Austin had not notified them of summonses issued for dangerous and careless driving in connection with the accident.

Austin had argued that, since the condition had never been brought to his notice, he was not bound by it.] Lord Greene MR: ‘Here is a case where Austin, a stranger to the policy altogether, paying no part of the premium and not being a party in contractual relations with the Zurich company, seeks to take the benefit of a clause in Aldridge’s policy which he can only obtain by reason of a certain statutory provision. I do not think it can be suggested that, apart from statute, any contract could be spelt out in circumstances such as this between Austin and the Zurich company. But, by reason of section 36, sub-section 4, of the Road Traffic Act, 1930, Austin had a right to sue the Zurich company… Here then is the plaintiff endeavouring to take advantage of the indemnity which Aldridge’s policy purports to give to him, and he is claiming a benefit under a document to which he is not a party. I should have thought myself that it was scarcely arguable that a person who claims the benefit of a document in that way is not bound to take it as he finds it. He must take it with all its disadvantages from his point of view, together with its advantages, and he cannot claim the benefit of anything which the document gives him without complying with its terms. I should have thought that that was not merely common sense, but a perfectly clear matter of principle…There is no contract, but there is a document which the plaintiff, the authorised driver, must take as he finds it. If that be not right, the authorised driver would be exempt from all these conditions. I can see no ground for excluding any of them, and he would be in an extremely fortunate position and the underwriters in an extremely unfortunate position, because the result would be that the benefits conferred on the authorised driver would be far better than the benefits conferred on the actual policyholder himself. It is not to be supposed that, where the policyholder

authorises somebody else to drive his car, the underwriters are in a position to tell that other person what the terms are on which he is going to be indemnified if he does drive the car. It is obviously not business and could never be effectively done.’

Subsequent legislation sought to deal with these problems. Under Road Traffic Act 1988, section 143 motorists are required to have third party liability insurance (see s 145), but that policy will not be effective until a certificate of insurance has been issued (see s 147). Moreover, the insurers’ liability is subject to certain conditions being met: The liability of the insurers to a third party requires: a judgment against any driver covered by the policy in respect of a liability covered by compulsory insurance; that the liability is covered by the policy and here those conditions that are rendered invalid as against a third party are ignored, but if, for instance, the car is used outside the clause covering the vehicle’s use, the insurers will not be liable and the only remedy will be against the insured. [1135] Road Traffic Act 1988 [Motor vehicle users are required to have insurance cover in respect of any liability for death or personal injury or damage to property arising out of the use of the vehicle (section 145; also sections 143–144). Under section 147 a policy of insurance is of no effect for the purposes of this part of the Act until the insurer has delivered to the policyholder a certificate

of insurance in the form prescribed and containing the conditions subject to which the policy is issued.] ‘section 148 (1) Where a certificate of insurance…has been delivered under section 147 of this Act to the person by whom a policy has been effected…has been given, so much of the policy…as purports to restrict— (a) the insurance of the persons insured by the policy… …by reference to any of the matters mentioned in subsection (2) below shall, as respects such liabilities as are required to be covered by a policy under section 145 of this Act, be of no effect. (2) Those matters are— (a) the age or physical or mental condition of persons driving the vehicle, (b) the condition of the vehicle, (c) the number of persons that the vehicle carries, (d) the weight or physical characteristics of the goods that the vehicle carries, (e) the time at which or the areas within which the vehicle is used, (f) the horsepower or cylinder capacity or value of the vehicle, (g) the carrying on the vehicle of any particular apparatus, or (h) the carrying on the vehicle of any particular means of identification other than any means of identification required to be carried by or under the Vehicle Excise and Registration Act 1994. … (4) Any sum paid by an insurer…in or towards the discharge of any liability of any person which is covered by the

policy…by virtue only of subsection (1) above is recoverable by the insurer…from that person. (5) A condition in a policy…issued…for the purposes of this Part of this Act providing— (a) that no liability shall arise under the policy…, or (b) that any liability so arising shall cease, in the event of some specified thing being done or omitted to be done after the happening of the event giving rise to a claim under the policy…, shall be of no effect in connection with such liabilities as are required to be covered by a policy under section 145 of this Act. (6) Nothing in subsection (5) above shall be taken to render void any provision in a policy…requiring the person insured or secured to pay to the insurer…any sums which the latter may have become liable to pay under the policy…and which have been applied to the satisfaction of the claims of third parties. (7) Notwithstanding anything in any enactment, a person issuing a policy of insurance under section 145 of this Act shall be liable to indemnify the persons or classes of persons specified in the policy in respect of any liability which the policy purports to cover in the case of those persons or classes of persons. … section 151 (1) This section applies where, after a certificate of insurance…has been delivered under section 147 of this Act to the person by whom a policy has been effected… a judgment to which this subsection applies is obtained. (2) Subsection (1) above applies to judgments relating to a liability with respect to any matter where liability with respect to that matter is required to be covered by a

policy of insurance under section 145 of this Act and either — (a) it is a liability covered by the terms of the policy…to which the certificate relates, and the judgment is obtained against any person who is insured by the policy…, or (b) it is a liability, other than an excluded liability, which would be so covered if the policy insured all persons…covered the liability of all persons, and the judgment is obtained against any person other than one who is insured by the policy… (3) In deciding for the purposes of subsection (2) above whether a liability is or would be covered by the terms of a policy…, so much of the policy…as purports to restrict, as the case may be, the insurance of the persons insured by the policy…by reference to the holding by the driver of the vehicle of a licence authorising him to drive it shall be treated as of no effect. (4) In subsection (2)(b) above “excluded liability” means a liability in respect of the death of, or bodily injury to, or damage to the property of any person who, at the time of the use which gave rise to the liability, was allowing himself to be carried in or upon the vehicle and knew or had reason to believe that the vehicle had been stolen or unlawfully taken, not being a person who — (a) did not know and had no reason to believe that the vehicle had been stolen or unlawfully taken until after the commencement of his journey, and (b) could not reasonably have been expected to have alighted from the vehicle. In this subsection the reference to a person being carried in or upon a vehicle includes a reference to a person entering or getting on to, or alighting from, the vehicle.

(5) Notwithstanding that the insurer may be entitled to avoid or cancel, or may have avoided or cancelled, the policy…, he must, subject to the provisions of this section, pay to the persons entitled to the benefit of the judgment — (a) as regards liability in respect of death or bodily injury, any sum payable under the judgment in respect of the liability, together with any sum which, by virtue of any enactment relating to interest on judgments, is payable in respect of interest on that sum, (b) as regards liability in respect of damage to property, any sum required to be paid under subsection (6) below, and (c) any amount payable in respect of costs. … (7) Where an insurer becomes liable under this section to pay an amount in respect of a liability of a person who is insured by a policy…, he is entitled to recover from that person — (a) that amount, in a case where he became liable to pay it by virtue only of subsection (3) above, or (b) in a case where that amount exceeds the amount for which he would, apart from the provisions of this section, be liable under the policy…in respect of that liability, the excess. (8) Where an insurer becomes liable under this section to pay an amount in respect of a liability of a person who is not insured by a policy…, he is entitled to recover the amount from that person or from any person who — (a) is insured by the policy…by the terms of which the liability would be covered if the policy insured all persons…covered the liability of all persons, and

(b) caused or permitted the use of the vehicle which gave rise to the liability. (9) In this section — …(c) “liability covered by the terms of the policy…” means a liability which is covered by the policy… or which would be so covered but for the fact that the insurer is entitled to avoid or cancel, or has avoided or cancelled, the policy… … section 152 (1) No sum is payable by an insurer under section 151 of this Act — … (c) in connection with any liability if, before the happening of the event which was the cause of the death or bodily injury or damage to property giving rise to the liability, the policy…was cancelled by mutual consent or by virtue of any provision contained in it, and also — (i) before the happening of that event the certificate was surrendered to the insurer, or the person to whom the certificate was delivered made a statutory declaration stating that the certificate had been lost or destroyed, or (ii) after the happening of that event, but before the expiration of a period of fourteen days from the taking effect of the cancellation of the policy… the certificate was surrendered to the insurer, or the person to whom it was delivered made a statutory declaration stating that the certificate had been lost or destroyed, or (iii) either before or after the happening of that event, but within that period of fourteen days,

the insurer has commenced proceedings under this Act in respect of the failure to surrender the certificate. (2) Subject to subsection (3) below, no sum is payable by an insurer under section 151 of this Act if, in an action commenced before, or within three months after, the commencement of the proceedings in which the judgment was given, he has obtained a declaration — (a) that, apart from any provision contained in the policy…he is entitled to avoid it on the ground that it was obtained — (i) by the non-disclosure of a material fact, or (ii) by a representation of fact which was false in some material particular, or (b) if he has avoided the policy…on that ground, that he was entitled so to do apart from any provision contained in it and, for the purposes of this section, “material” means of such a nature as to influence the judgment of a prudent insurer in determining whether he will take the risk and, if so, at what premium and on what conditions. (3) An insurer who has obtained such a declaration as is mentioned in subsection (2) above in an action does not by reason of that become entitled to the benefit of that subsection as respects any judgment obtained in proceedings commenced before the commencement of that action unless before, or within seven days after, the commencement of that action he has given notice of it to the person who is the plaintiff…in those proceedings specifying the non-disclosure or false representation on which he proposes to rely.’

Notes: Other legislation allowing direct claims against an insurer includes the Merchant Shipping Act 1995

(previously the Merchant Shipping (Oil Pollution) Act 1971), which was prompted by concerns about the losses caused by the spillage of oil from tankers. This Act imposes an obligation on oil tankers to carry liability insurance and enables third parties to proceed directly against the insurer, although the insurer can defend such claims by, among other things, showing that the discharge of oil was due to the wilful misconduct of the owner (see sections 163– 65).

12 Subrogation, Abandonment and Double Insurance 12.1 Definition Subrogation arises as a consequence of the indemnity principle and refers to the right of an insurer, who has paid for a loss, to pursue the wrongdoer in the name of the insured. It enables liability for loss to be fixed to the person responsible without allowing the insured to recover from both that person and the insurer, which would violate the principle of indemnity. [1201] Castellain v Preston (1883) 1 QBD 380 [The vendor of a house contracted for its sale. The house was insured against fire and the sale contract contained no reference to insurance. Between the date of the contract and completion, the house was damaged by fire and the insurers paid the vendor for the loss. The purchase was then completed and the vendor received the full price agreed in the contract.

It was held that the insurers were entitled to recover the amount of their payment to the vendor.] Brett, LJ: ‘In order to give my opinion upon this case, I feel obliged to revert to the very foundation of every rule which has been promulgated and acted on by the Courts with regard to insurance law. The very foundation, in my opinion, of every rule which has been applied to insurance law is this, namely, that the contract of insurance contained in a marine or fire policy is a contract of indemnity, and of indemnity only, and that this contract means that the assured, in case of a loss against which the policy has been made, shall be fully indemnified, but shall never be more than fully indemnified. That is the fundamental principle of insurance, and if ever a proposition is brought forward which is at variance with it, that is to say, which either will prevent the assured from obtaining a full indemnity, or which will give to the assured more than a full indemnity, that proposition must certainly be wrong…I have mentioned the doctrine of notice of abandonment for the purpose of coming to the doctrine of subrogation. That doctrine does not arise upon any of the terms of the contract of insurance, it is only another proposition which has been adopted for the purpose of carrying out the fundamental rule which I have mentioned, and it is a doctrine in favour of the underwriters or insurers in order to prevent the assured from recovering more than a full indemnity; it has been adopted solely for that reason. It is not, to my mind, a doctrine applied to insurance law on the ground that underwriters are sureties. Underwriters are not always sureties. They have rights which sometimes are similar to the rights of sureties, but that again is in order to prevent the assured from recovering from them more than a full indemnity. But it being admitted that the doctrine of

subrogation is to be applied merely for the purpose of preventing the assured from obtaining more than a full indemnity, the question is, whether that doctrine as applied in insurance law can be in any way limited. Is it to be limited to this, that the underwriter is subrogated into the place of the assured so far as to enable the underwriter to enforce a contract, or to enforce a right of action? Why is it to be limited to that, if when it is limited to that, it will, in certain cases, enable the assured to recover more than a full indemnity? The moment it can be shewn that such a limitation of the doctrine would have that effect, then, as I said before, in my opinion, it is contrary to the foundation of the law as to insurance, and must be wrong. And, with the greatest deference to my Brother Chitty, it seems to me that that is the fault of his judgment. He has by his judgment limited this doctrine of subrogation to placing the insurer in the position of the assured only for the purpose of enforcing a right of action, to which the assured may be entitled. In order to apply the doctrine of subrogation, it seems to me that the full and absolute meaning of the word must be used, that is to say, the insurer must be placed in the position of the assured. Now it seems to me that in order to carry out the fundamental rule of insurance law, this doctrine of subrogation must be carried to the extent which I am now about to endeavour to express, namely, that as between the underwriter and the assured the underwriter is entitled to the advantage of every right of the assured, whether such right consists in contract, fulfilled or unfulfilled, or in remedy for tort capable of being insisted on or already insisted on, or in any other right, whether by way of condition or otherwise, legal or equitable, which can be, or has been exercised or has accrued, and whether such right could or could not be enforced by the insurer in the name of the assured by the exercise or acquiring of which right or condition the loss against which the assured is insured, can be, or has been diminished. That seems to me

to put this doctrine of subrogation in the largest possible form, and if in that form, large as it is, it is short of fulfilling that which is the fundamental condition, I must have omitted to state something which ought to have been stated. But it will be observed that I use the words “of every right of the assured.” I think that the rule does require that limit. In Burnand v Rodocanachi (7 App Cas 333) the foundation of the judgment to my mind was, that what was paid by the United States Government could not be considered as salvage, but must be deemed to have been only a gift. It was only a gift to which the assured had no right at any time until it was placed in their hands. I am aware that with regard to the case of reprisals, or that which a person whose vessel had been captured got from the English Government by a way of reprisal, the sum received has been stated to be, and perhaps in one sense was, a gift of his own Government to himself, but it was always deemed to be capable of being brought within the range of the law as to insurance, because the English Government invariably made the “gift,” so invariably, that as a matter of business it had come to be considered as a matter of right. This enlargement, or this explanation, of what I consider to be the real meaning of the doctrine of subrogation, shews that in my opinion it goes much further than a mere transfer of those rights which may at any time give a cause of action either in contract or in tort, because if upon the happening of the loss there is contract between the assured and a third person, and if that contract is immediately fulfilled by the third person, then there is no right of action of any kind into which the insurer can be subrogated. The right of action is gone; the contract is fulfilled. In like manner if upon the happening of a tort the tort is immediately made good by the tortfeasor, then the right of action is gone; there is no right of action existing into which the insurer can be subrogated. It will be said that there did for a moment exist a right of action in favour of the assured, into which the

insurer could have been subrogated. But he cannot be subrogated into a right of action until he has paid the sum insured and made good the loss. Therefore innumerable cases would be taken out of the doctrine, if it were to be confined to existing rights of action. And I go further and hold that if a right of action in the assured has been satisfied, and the loss has been thereby diminished, then, although there ever was nor could be any right of action into which the insurer could be subrogated, it would be contrary to the doctrine of subrogation to say that the loss is not to be diminished as between the assured and the insurer by reason of the satisfaction of that right. I fail to see at present if the present defendants would have had a right of action at any time against the purchasers, upon which they could enforce a contract of sale of their property whether the building was standing or not, why the insurance company should not have been subrogated into that right of action. But I am not prepared to say that they could be, more particularly as I understand my learned Brother, who knows much more of the law as to specific performance than I do, is at all events not satisfied that they could. I pass by the question without solving it, because there was a right in the defendants to have the contract of sale fulfilled by the purchasers notwithstanding the loss, and it was fulfilled. The assured have had the advantage therefore of that right, and by that right, not by a gift which the purchasers could have declined to make, the assured have recovered, notwithstanding the loss, from the purchasers, the very sum of money which they were to obtain whether this building was burnt or not. In that sense I cannot conceive that a right, by virtue of which the assured has his loss diminished, is not a right which, as has been said, affects the loss. This right which was at one time merely in contract, but which was afterwards fulfilled, either when it was in contract only, or after it was fulfilled, does affect the loss; that is to say, it affects the loss by enabling the assured, the vendors, to get

the same money which they would have got if the loss had not happened.’

Cotton LJ: ‘The policy is really a contract to indemnify the person insured for the loss which he has sustained in consequence of the peril insured against which has happened, and from that it follows, of course, that as it is only a contract of indemnity, it is only to pay that loss which the assured may have sustained by reason of the fire which has occurred. In order to ascertain what that loss is, everything must be taken into account which is received by and comes to the hand of the assured, and which diminishes that loss. It is only the amount of the loss, when it is considered as a contract of indemnity, which is to be paid after taking into account and estimating those benefits or sums of money which the assured may have received in diminution of the loss. If the proposition is stated in that manner, it is clear that the office would be entitled to the benefit of anything received by the assured before the time when the policy is paid, and it is established by the case of Darrell v Tibbitts (5 QBD 560) that the insurance company is entitled to that benefit, whether or not before they pay the money they insist upon a calculation being made of what can be recovered in diminution of the loss by the assured; if they do not insist upon that calculation being made, and if it afterwards turns out that in consequence of something which ought to have been taken into account in estimating the loss, a sum of money or even a benefit, not being a sum of money, is received, then the office, notwithstanding the payment made, is entitled to say that the assured is to hold that for its benefit, and although it was not taken into account in ascertaining the sum which was paid, yet when it has been received it must be brought into account, and if it is not a sum of money, but a benefit that has been received, its value must be estimated in money.’

Notes: 1. In Lord Napier and Ettrick v Hunter [1993] AC 713, the House of Lords construed the idea of indemnity in light of the contract, so that the rights of subrogation arose once the insurers had met their obligations under that contract, even though the insured’s loss might not have been fully covered: C Mitchell, “Defences to an Insuer’s Subrogated Action” [1996] LMCLQ 343 at 348. 2. Much subrogation litigation concerns the insurers’ rights against a tortfeasor. However, subrogation to the insured’s contractual rights is also an important but problematic area, and, of course, Castellain itself is concerned with contract rights. Policies normally contain express terms entitling the insurer to assume the insured’s relevant rights of action, and it is clear that the parties can (as will be seen) expressly agree to vary subrogation rights: Anon, “Note: Subrogation of the Insurer to Collateral Rights of the Insured” [1951] Columbia L Rev 202; J Bird, “Contractual Subrogation in Insurance” [1979] JBL 124; Mitchell, The Law of Subrogation, (Oxford, Clarendon Press, 1994)). [1202] Somersall v Friedman (2002) 215 DLR (4th) 577 (Supreme Court of Canada) Iacobucci J (McLachlin C.J. and L’Heureux-Dubé, Gonthier, and LeBel JJ concurring):

‘…it is important to keep in mind the underlying objectives of the doctrine of subrogation which are to ensure (i) that the insured receives no more and no less than a full indemnity, and (ii) that the loss falls on the person who is legally responsible for causing it…The doctrine of subrogation operates to ensure that the insured received only a just indemnity and does not profit from the insurance: see Castellain v Preston (1883), 11 QBD 380 (CA), at pp 386–87; AFG Insurances Ltd v City of Brighton (1972), 126 CLR 655 (HC Austrl)…Consequently, if there is no danger of the insured’s being over-compensated and the tortfeasor has exhausted his or her capacity to compensate the insured there is no reason to invoke subrogation. Similarly, if the insured enters into a limits agreement or otherwise abandons his or her claim against an impecunious tortfeasor the insurer has lost nothing by the inability to be subrogated.’

[1203] Patent Scaffolding Co v William Simpson Construction Co 64 Cal Rptr 187 (California, Court of Appeal, 1967) Hufstedler J: ‘The elements of an insurer’s cause of action based upon equitable subrogation are these: (1) The insured has suffered a loss for which the party to be charged is liable, either because the latter is a wrongdoer whose act or omission caused the loss or because he is legally responsible to the insured for the loss caused by the wrongdoer; (2) the insurer, in whole or in part, has compensated the insured for the same loss for which the party to be charged is liable; (3) the insured has an existing, assignable cause of action against the party to be charged, which action the insured could have asserted for his own benefit had he not been compensated for his loss by the

insurer; (4) the insurer has suffered damages caused by the act or omission upon which the liability of the party to be charged depends; (5) justice requires that the loss should be entirely shifted from the insurer to the party to be charged, whose equitable position is inferior to that of the insurer; and (6) the insurer’s damages are in a stated sum, usually the amount it has paid to its insured, assuming the payment was not voluntary and was reasonable… No express assignment of the insured’s cause of action is required; equitable subrogation is accomplished by operation of law. However, as in cases of assignment, the equitable subrogee is substituted only in respect of a subrogor’s causes of action which are not purely personal and, generally, any defenses or counterclaims which could have been asserted against the subrogor-insured can also be asserted against the subrogee-insurer.’

[1204] Welch Foods, Inc v Chicago Insurance Company 17 SW3d (Supreme Court of Arkansas, 2000)

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Lavenski R Smith, J: ‘Subrogation at its essence is the substitution of one party for another in the exercise of some legal right…Subrogation is routinely divided into two types. They are conventional subrogation and legal subrogation. The distinction relates to the facts giving rise to the substitution of rights. “Conventional subrogation, as the term implies, is founded upon some understanding or agreement, express or implied, and without which there is no ‘convention.’” Courtney v Birdsong 246 Ark 162, 437 SW2d 238 (1969). Legal or equitable subrogation, on the other hand, is a creature of equity, and not dependent upon contract, but rather dependent upon the equities of the parties. It arises by operation of law. [ibid at 166]

Whether by agreement or by operation of law, the very concept of subrogation is of equitable origin…This equity arises when one not primarily bound to pay a debt, or remove an incumbrance, nevertheless does so; either from his legal obligation, as in the case of a surety, or to protect his own secondary right; or upon the request of the original debtor, and upon the faith that, as against the debtor, the person paying will have the same sureties for reimbursement as the creditor had for payment. Subrogation is a doctrine steeped in equity and generally governed by equitable principles.’

Note: 1. In some parts of the US legislation provides for subrogation in respect of particular types of insurance, such as uninsured motor insurance (that is, cover for loss caused by an uninsured motorists), Indiana Code 27-7-5-6. This is uncommon in English Law, but for an example see the Riots (Damages) Act 1886 section 2(2). 2. The US courts tend to be more explicit in their pursuit of policy goals in this area than the English courts. These goals are that the wrongdoer should bear the loss and that the insured should not be able to recover twice (that is, both from the wrongdoer and the insurer (see Madsen v Threshermen’s Mutual Insurance Company, below). [1205] C Mitchell, The Law of Subrogation (Oxford, Clarendon Press, 1994) at 68–74 [Footnotes Omitted]

‘When an insured who has suffered an insured loss is entitled not only to recover in respect of the loss from his insurer, but also to receive some benefit from a third party in reduction or extinction of the insured loss, the principle of indemnity is potentially threatened if the combined total of the amounts which the insured is entitled to receive from the insurer and the third party exceeds the amount of his loss. To prevent the insured from being more than fully indemnified for his loss in such circumstances, the courts have developed three different remedies which are variously available to the insurer according to the relationship which exists between the three parties at the time of the court’s intervention. It is common to find statements in the case law and in academic works to the effect that all of these remedies are awarded in order to enforce the insurer’s right of subrogation, or as incidents of the doctrine of subrogation. However, this usage of the word ‘subrogation’ is misleading. It derives from the Court of Appeal’s judgments in two nineteenth century cases, Darrell v Tibbitts [(1880) 5 QBD 560] and Castellain v Preston [see [1201]], which are discussed at (1) below. The remedies in question are awarded in order to enforce the principle of indemnity for the insurer’s benefit. One of them is the remedy of simple subrogation. The other two are not. They are distinct remedies, used in response to different situations, and they work in different ways. To conflate them with simple subrogation leads to confusion and misunderstanding of the way in which they and the remedy of simple subrogation actually work. The three remedies developed by the courts to enforce the principle of indemnity arise in the following three situations: (a) An insured suffers an insured loss. The insurer pays the insured for his loss. The insured has a subsisting right of action against a third party in respect of the insured loss. In these circumstances, provided that it has fully

indemnified the insured for his loss, the insurer is entitled to take over the insured’s right of action via simple subrogation; that is, the insurer can pursue the insured’s subsisting right of action against the third party in the insured’s name for its own benefit. (b) An insured suffers an insured loss. Unknown to the insurer he then receives a payment in respect of that loss from a third party. The insurer then pays the insured for his loss. In these circumstances, the insurer is entitled to recover back from the insured so rnuch of its payment as brought the total of the amounts received by the insured from the third party and the insurer above the amount of the insured loss, as money had and received, paid by mistake of fact. The insurer’s mistake was to think that the insured had suffered a greater loss than was in fact the case, once the insured had received the third party’s payment in respect of the loss. (c) An insured suffers an insured loss. The insurer pays him on the policy. The insured then receives a payment in respect of the same loss from a third party, which brings the total of the amounts that the insured has received in respect of his loss above the amount of his loss. In these circumstances, the insurer is entitled to bring a claim against the insured for so much of the money paid by the third party to the insured as more than fully indemnifies the insured for his loss. It has recently been held by the House of Lords in Lord Napier and Ettrick v Hunter [[1993] AC 713] that the money received by the insured from the third party is subject to an equitable lien in the insurer’s favour… In the following discussion, the two cases which lie at the heart of much of the terminological confusion in this area, Darrell v Tibbitts and Castellain v Preston, will be considered…

(1) Darrell v Tibbitts and Castellain v Preston The significance of these two cases is that they were decided by the Court of Appeal on the basis of flawed reasoning which has been tacitly or expressly adopted in the case law ever since, with evil consequences for the clarity of the law in this area. In Darrell v Tibbitts [(1880) 5QBD 560], the earlier of the two, the defendant was the owner of a house let to a tenant. Under the terms of the lease the tenant was obliged to repair the house in the event that it was damaged. The defendant insured the house with the plaintiff insurers against damage caused, inter alia, by gas explosions. An employee of the local authority negligently caused a gas explosion which damaged the house. The local authority paid compensation in respect of this damage to the tenant, who used the money to repair the house as he was bound to do by the terms of the lease. The plaintiff insurers, unaware that the tenant had effected these repairs, then paid the defendant insured for the loss. When all the facts subsequently came to light, the insurers brought an action against the defendant seeking to recover their payment. The grounds upon which the insurers should have been entitled to recover were that they had made the insured a payment to which he was not entitled under a mistake of fact, which payment they should have been able to recover as money had and received to the defendant’s use. This emerges quite clearly in Thesiger LJ’s judgment, where he stated that [at 567–8]: “[T]his suit may be supported upon one of two grounds: [the insurer’s right of subrogation, and]…an action at common law for money had and received, to recover the sum which they paid upon the ground that that money was paid upon the conditions, that the person to whom it was paid had sustained a loss, that in point of fact no loss had been

sustained, and therefore that the money paid by the company ought in justice be returned to them.” Brett and Cotton LJJ [at 563, 564–5], however, sought to put more emphasis upon the first ground referred to in the passage quoted above: in their view, the insurers were entitled to be subrogated to the defendant insured’s rights against the tenant, and hence to claim from the insured the value of the reinstatement of the property effected by the tenant. Brett and Cotton LJJ were guilty of a confusion here: on the facts of the case, subrogation was an inappropriate technique to give effect to the insurers’ right of recovery against the insured. The tenant had performed his obligations to the insured, leaving nothing to which the insurers could have claimed to be simply subrogated. And it would have been equally inappropriate to award the insurers reviving subrogation in the case: reviving subrogation is a remedy which should be awarded to a claimant S [the insurer] only where RH’s [the right holder, here the insured] rights have been extinguished by S’s payment, with the result that PL [the person with primary liability] is enriched at S’s expense. In Darrell v Tibbitts the position was fundamentally different: the insurer paid the insured, it is true, but it was not the insurer’s payment that operated to extinguish the insured’s rights against his tenant. Rather, the insured’s rights were extinguished because the tenant had himself performed his obligations to the insured. No questions therefore arose in the case of the tenant being enriched at the insurer’s expense and reviving subrogation could not have been an appropriate remedy to use. Three years after Darrell v Tibbitts, Castellain v Preston came before the Court of Appeal, and Brett and Cotton LJJ had the chance to elaborate their views on subrogation…In retrospect, it can be seen that the insurers [in Castellain] should have brought a claim…alleging that the defendant

insured owed a duty to account to them for sums received from a third party in respect of the insured loss. And indeed, it appears that this was one of the two alternative ways in which counsel for the insurers framed their claim (the insurers’ claim was framed in the alternative as an action for money had and received, a form of action that was inappropriate on the facts of the case because the insurers’ payment was made before rather than after the defendants’ receipt of money from the purchasers). It must be said therefore that the insurer’s case was presented to the courts in a distinctly confused manner. However, counsel for the insurers at least did not frame their claim as one of simple subrogation, to which the insurers could clearly not have been entitled either, since at the time the insurers’ action was brought, the defendants had already exercised their rights against the purchasers of the house; as in Darrell v Tibbitts, there were therefore no subsisting rights of action to which the insurers could have claimed to be simply subrogated. Chitty J, who heard the case at first instance, made this point very clearly during the course of his judgment. The main ratio of his decision in favour of the defendant insureds concerned the nature of the contract of sale, which he did not consider to be a contract relating to the subjectmatter of the insurance in such a way that the insurers should be entitled to take the benefit of it. [(1882) 8 QBD 613 at 621] On this particular point, Chitty J was mistaken in principle, since the effect of the defendants’ receipt of payments from both purchasers and insurers was undeniably to enrich the defendants twice over in respect of the same loss. More pertinent to the present discussion, though, is the fact that Chitty J took the principle of subrogation to be that “on payment the insurers are entitled to enforce all the remedies whether in contract or in tort, which the insured has against third parties, whereby the insured can compel such third parties to make good the loss

insured against” [at 617]. And he went on to hold that a prerequisite of the award of “subrogation” to an insured’s rights against a third party under a contract should be that “the contract [is] one which subsists at the time when the claim under the policy of insurance has been matured” [at 625]. In other words, Chitty J took the view that “subrogation” could only be used to transfer subsisting rights of action from the insured to the insurer: he assumed that the term “subrogation” used in the context of insurance law denotes the remedy of simple subrogation described in this book. His judgment on this point seems absolutely sound. He was wrong not to allow the insurers to recover the money received by the defendants in respect of the insured loss from the purchasers, but he was quite correct to hold that the insurers could not use the remedy of simple subrogation to effect their recovery. It was a technique inappropriate to the facts of the case. The Court of Appeal reversed Chitty J’s judgment, and found in favour of the insurers. In doing so, it reached the right result, but the reasoning it used to get there was fundamentally flawed. The main judgment in the Court of Appeal was delivered by Brett U, who took as his starting point the following statement [(1883) 11 QBD 380 at 386]: “The very foundation…of every rule which has been applied to insurance law is this, namely, that the contract of insurance contained in a marine or fire policy is a contract of indemnity, and of indemnity only, and that this contract means that the assured, in case of a loss against which the policy has been made, shall be fully indemnified, but shall never be more than fully indemnified.” In a well-known passage, he then went on to say that the doctrine of subrogation, “another proposition which has been adopted for the purpose of carrying out the

fundamental rule which I have mentioned”, should be expressed in the following way [at 388, emphasis added]: “[A]s between the underwriter and the assured the underwriter is entitled to the advantage of every right of the assured, whether such right consists in contract, fulfilled or unfulfilled, or in remedy for tort capable of being insisted on or already insisted on, or in any other right, legal or equitable, which can be, or has been exercised or has accrued.” And he expanded upon this statement [at 389–90]: “This enlargement, or this explanation, of what I consider to be the real meaning of the doctrine of subrogation, shews that in my opinion it goes much further than a mere transfer of those rights which may at any time give a cause of action either in contract or tort…[I]f a right of action in the assured has been satisfied, and the loss has been thereby diminished, then, although there never was nor could be a right of action into which the insurer could be subrogated, it would be contrary to the doctrine of subrogation to say that the loss is not to be diminished as between the assured and the insurer by reason of the satisfaction of that right.” It may be seen in this last passage that Brett LJ used the term “doctrine of subrogation” to describe something much wider than the remedy of simple subrogation, by which an insurer is substituted to the position of the insured in order to take over the insured’s subsisting rights of action. He used it in fact to denote the principle of indemnity, which underlies the award not only of the remedy of simple subrogation, but also of the other two remedies…[(b) and (c) above]. Brett LJ’s conflation in this passage of the remedy of (simple) subrogation with the principle underlying

the remedy’s award has been aptly described by James [(1971) 34 MLR 149 at 154]: “[Brett LJ managed to vindicate the insurers in Castellain v Preston]…in a judgment which has by mischance become a classic…by distorting the definition of subrogation so as to cover the case. He defined it so as to include ‘every right of the assured, whether the right consists in contract fulfilled or unfulfilled, or in remedy for tort capable of being insisted on or already insisted on.’ This is putting the cart of subrogation before the horse of the equity which motivates it: the cart has swallowed the horse. What Brett LJ was really defining was the equity, and not, as he purported to do, subrogation.” It is unfortunate that Brett LJ should have misused the term “subrogation” in this way. Following Castellain v Preston, his misuse of the term has been echoed in many of the cases and in much of the academic commentary of this area of the law. Thus, its long-term effect has been to introduce a confusion into the heart of the law in this area which has rendered its workings obscure and which must be stripped away before the remedies made available by the courts to an insurer with a view to enforcing the principle of indemnity can properly be understood.’

Note: Mitchell also noted the comments of an Australian court: ‘Castellain v Preston of course was not a case of subrogation in respect of an outstanding right of action and one might almost wish that some other word had been used as the label of a right which exists when it is too late for subrogation in its ordinary sense’, British Traders’ Insurance Co Ltd v

Monson (1964) 111 CLR 86 at 94, per Kitto, Taylor, and Owen JJ.

12.2 Subrogation and Indemnity The right of subrogation only arises where there is an obligation on the insurer to indemnify the insured. It is, therefore, not available in relation to life assurance (Solicitors and General v Lamb (1864) 1 De GJ & Sm 251) or honour policies (John Edwards and Co v Motor Union Insurance Co Ltd, see [1206]). Furthermore, it only arises once the insurers have met their full liability under the policy in respect of the relevant incident. [1206] John Edwards and Co v Motor Union Insurance Co Ltd [1922] 2 KB 249 (CA) [Following a collision at sea, the owners of a vessel received a payment from their insurers, Motor Union, which included a sum for the loss of hire charges on the vessel. Subsequently, the owners of the other vessel involved in the collision compensated for the loss of that hire and Motor Union now sought to recover that amount. The policy was a ppi (policy proof of interest) or honour policy, that is, the insurers agreed that mere production of the policy would be accepted by them as proof of an insurable interest. Such a policy is void under the Marine Insurance Act 1906, section 4(2)(b).]

McCardie J: ‘…the principle of subrogation is ever a latent and inherent ingredient of the contract of indemnity, but that it does not become operative or enforceable until actual payment be made by the insurer. It derives its life from the original contract. It gains its operative force from payment under that contract. Not till payment is made does the equity, hitherto held in suspense, grasp and operate upon the assured’s choses in action. In my view the essence of the matter is that subrogation springs not from payment only but from actual payment conjointly with the fact that it is made pursuant to the basic and original contract of indemnity. If then the right of subrogation rests upon payment under a contract of indemnity, how does the matter stand when the policy of insurance is an honour policy only? In my opinion such a policy is not a contract of indemnity at all. It is the negation of such a contract…’

[1207] Marine Insurance Act 1906 section 79 (1) ‘Where the insurer pays for a total loss, either of the whole, or in the case of goods of any apportionable part, of the subject-matter insured, he thereupon becomes entitled to take over the interest of the assured in whatever may remain of the subject-matter so paid for, and he is thereby subrogated to all the rights and remedies of the assured in and in respect of that subject-matter as from the time of the casualty causing the loss. (2) Subject to the foregoing provisions, where the insurer pays for a partial loss, he acquires no title to the subject-matter insured, or such part of it as may remain, but he is thereupon subrogated to all rights and remedies of the assured in and in respect of the subject-

matter insured as from the time of the casualty causing the loss, in so far as the assured has been indemnified, according to this Act, by such payment for the loss.’

[1208] Page v Scottish Insurance Corporation Ltd (1929) 33 Ll L R 134 (CA) [Forster’s car, which was insured with Scottish Insurance, was involved in an accident while being driven negligently by Page. Both Forster’s car and a car owned by Stobbart were damaged. The insurers agreed to Page undertaking the repairs to Forster’s car, but failed to pay him. Page claimed against the insurers who responded by claiming from Page, as the wrongdoer, an amount equivalent to the cost of the repairs. At this time, the insurers had failed to settle the claim by Stobbart against Forster and Page.] Scrutton LJ: ‘Now as to liability. Subrogation has to be carefully distinguished from abandonment of the property insured. On abandonment the property and all its incidents pass to the underwriter to whom it is abandoned; and it is quite possible — I have known cases myself in my own practice where underwriters have made an extremely good thing by accepting abandonment because they have got something more than the amount they have had to pay. On abandonment they acquire a title and they sue in their own name. Subrogation is quite a different thing. It is a kind of equitable right of underwriters who have indemnified the assured, diminishing their loss by using for their own benefit any legal rights which the assured could have enforced in respect of the subject-matter insured. But in the case of

subrogation the underwriter cannot sue in his own name. His rights are the rights of the assured. In the well- known case of Simpson v Thomson, 3 App Cas 279 [1211], where there was a collision between ships, both owned by the assured, and each was negligent, the underwriter was unable to get the benefit of the owner’s claim against money paid into Court by the second ship in limitation of liability proceedings because he could only get it out by saying the first ship had a right against the second ship, and as the owner could not sue himself there was no money that the underwriter could get the benefit of. But I always understood that the underwriter had no right to subrogation until he had fully indemnified the assured under the policy. When he had fully indemnified the assured he then had the equitable right to diminish his loss by using in his own favour and in the name of the assured any rights the assured could use against a third party in respect of the subject-matter of the loss. …It is said that at the time the writ was issued the underwriter had paid all that was due in respect of the particular claim for which the writ was issued and that it does not matter that there was some other claim under the same policy and in respect of some expenditure which the underwriter had not paid. That is said to be the position in this case. The insurer says: “True, I was disputing the amount you claimed in respect of third-party liability, but I had by reinstatement made good to you so that you suffered no loss by the damage to your own car. Consequently, I was entitled to be subrogated to that part of your claim under the policy irrespective of the fact that there was a claim which I had not paid.” I think that that is an erroneous view of the doctrine of subrogation. I think the right to be subrogated to the rights of the assured does not pass to the underwriter until he has satisfied all the claims under the policy in respect of the particular subject-matter, and that if you get one car, one accident, one policy and

one premium, I do not think that the underwriter can claim to be subrogated until he has satisfied all the claims arising out of that policy and paid for by that one premium in respect of that one accident and that one car.’

Notes: 1. In King v Victoria Insurance Co Ltd [1896] AC 250 (HL), it was held that where an insurer had paid out on a claim in the honest and reasonable belief that it came within the terms of the policy, the tortfeasor could not defend an action by alleging that there had been no liability under the policy. 2. In Caledonia North Sea Ltd v Telecommunications plc [2002] 1 Lloyd’s Rep 553 (HL), a case on the Piper Alpha oil platform disaster, it was held that where a contractor had contracted to indemnify an operator of the platform for any claim brought against the latter relating to the contractor’s employees. In addition, the operator took out insurance against such liability. After the disaster, the insurers paid claims made by the contractor’s employees and then sought to enforce the indemnity. The House of Lords rejected the contractor’s argument that since the operator was insured they had suffered no loss. Lord Bingham pointed out that the operator was under no obligation to insure, so it would be anomalous to allow that voluntary action to enable the contractor to escape the liability for which it had contracted.

12.3 Subrogation Denied 12.3.1 Denial where Subrogation would Cause Injustice The insurer takes action in the name of the insured, unless the insured assigns the right of action to the insurer (in many US states the insurer has the option to take action in their own name or that of the insured: see Slack v Kirk 67 Pa 380 (1871)). The court will normally compel the insured to lend her or his name to such action: for a rare exception when the court refused to do so, see Morris v Ford Motor Co [1973] 1 QB 792 (CA). Under an agreement between Ford and a cleaning firm, the latter agreed to indemnify Ford for the negligence of the employees of either company. Mr Morris was injured by the negligent act of a Ford employee. He successfully sued Ford; Ford sought an indemnity from the cleaning firm; and the cleaning firm claimed that, since they were indemnifying Ford, they were entitled to sue Ford’s negligent employee. The Court of Appeal refused to compel Ford to lend its name to such an action. Lord Denning MR argued that it was unjust to force the employer to lend its name to an action against an employee since it could endanger industrial relations. He added: ‘where the risk of a servant’s negligence is covered by insurance, his employer should not seek to make that

servant liable for it. At any rate, the courts should not compel him to allow his name to be used to do it.’

He based his refusal on the ground that as subrogation originated in equity the court had a discretion to compel the employer and would refuse where it was unjust. He added that if subrogation originated in an implied term in the contract, then in this case he would not imply such a term. The Morris decision came after the House of Lords had taken the view that an insurer could subrogate against an employee (Lister v Romford Ice and Cold Storage Co Ltd [1957] AC 555). Lord Denning did not trouble to conceal his dislike of that case, calling it ‘an unfortunate decision’. He drew further encouragement from the (non-legally binding) statement by the British Insurers’Association, issued after Lister, to the effect that insurers would not normally institute claims against employees of an insured. Lord Denning felt able to ignore Lister because the facts in the two cases were not precisely similar. James LJ took the less controversial view that there was an implied term in the contract that the cleaning company would not take action against a Ford employee, although this does seem to contradict the express agreement of the parties. [1209] The “Yasin” [1979] 2 Lloyd’s Rep 45 Lloyd J: ‘Lord Justice James [in Morris v Ford Motor Co] regarded the point as being finely balanced. He came down in favour of

implied term because of the industrial setting; but there is nothing equivalent to that in the present case. It is an ordinary commercial contract; and, applying the ordinary rules of implication in commercial contracts, I can see no necessity for implying any term excluding the right of subrogation against the defendants. Indeed, as Mr Reynolds forcibly pointed out, any such implied term would be contrary to the express term in clause 9 of the Institute Cargo Clauses, which provides: It is the duty of the assured or their agents in all cases to take such measures as may be reasonable for the purpose of averting or minimising a loss or to ensure that all rights against carriers, bailees or other third parties are properly preserved and exercised.

As to the ground on which Lord Denning, MR, decided Morris v Ford Motor Co, namely that it would have been unjust to allow the right of subrogation to be exercised against the servant in that case, I can see no injustice in the present case.’

[1210] Insurance Australia)

Contracts

Act

1984

(Cth:

‘section 65 (1) Subject to subsection (2), this section applies where: (a) an insurer is liable under a contract of general insurance in respect of a loss; (b) but for this section, the insurer would be entitled to be subrogated to the rights of the insured against some other person (in this section called the “third party”); and (c) the insured has not exercised those rights and might reasonably be expected not to exercise those rights by reason of: (i) a family or other personal relationship between the insured and the third party; or

(ii) the insured having expressly or impliedly consented to the use, by the third party, of a road motor vehicle that is the subject-matter of the contract. (2) This section does not apply where the conduct of the third party that gave rise to the loss: (a) occurred in the course of or arose out of the third party’s employment by the insured; or (b) was serious or wilful misconduct. (3) Where the third party is not insured in respect of the third party’s liability to the insured, the insurer does not have the right to be subrogated to the rights of the insured against the third party in respect of the loss. (4) Where the third party is so insured, the insurer may not, in the exercise of the insurer’s rights of subrogation, recover from the third party an amount that exceeds the amount that the third party may recover under his contract of insurance in respect of the loss. (5) An insured need not comply with a condition requiring the insured to assign those rights to the insurer in order to be entitled to payment in respect of the loss and an insurer shall not purport to impose such a condition on the making of such a payment or, before making such a payment, invite the insured so to assign those rights, or suggest that the insured so assign them. … (6) An assignment made in compliance with such a condition or in pursuance of such an invitation or suggestion is void. (7) In subsection (1), “road motor vehicle” means a motor vehicle that is so constructed as to be capable of carrying by road at least one person other than the driver. section 66 Where:

(a) the rights of an insured under a contract of general insurance in respect of a loss are exercisable against a person who is the insured’s employee; and (b) the conduct of the employee that gave rise to the loss occurred in the course of or arose out of the employment and was not serious or wilful misconduct; the insurer does not have the right to be subrogated to the rights of the insured against the employee.’

Note: The National Consumer Council has argued for reform of the English law on subrogation in terms similar to those in the Insurance Contracts Act: J Birds with F Harrison, Insurance Law Reform: The Consumer Case for a Review of Insurance Law (London, National Consumer Council, 1997) 12.3.2 Action Against the Insured or CoInsured [1211] Simpson & Co v Thomson, Burrell (1877) 3 App Cas 279 (HL) [Two ships, both owned by Burrell, collided causing damage to one of the ships, ‘Dunluce Castle’, for which the owner claimed under his insurance policy. It was held that the insurers could not use their rights of subrogation to claim against Burrell as owner of the ‘Fitzmaurice’, the ship that was, in part, responsible for the loss.] Lord Cairns LC:

‘I know of no foundation for the right of underwriters, except the well-known principle of law, that where one person has agreed to indemnify another, he will, on making good the indemnity, be entitled to succeed to all the ways and means by which the person indemnified might have protected himself against or reimbursed himself for the loss. It is on this principle that the underwriters of a ship that has been lost are entitled to the ship in specie if they can find and recover it; and it is on the same principle that they can assert any right which the owner of the ship might have asserted against a wrongdoer for damage for the act which has caused the loss. But this right of action for damages they must assert, not in their own name but in the name of the person insured, and if the person insured be the person who has caused the damage, I am unable to see how the right can be asserted at all.’

Note: For a critique, see PS James, “The Fallacies of Simpson v Thomson” (1971) 22 MLR 149. [1212] National Oilwell (UK) Ltd v Davy Offshore Ltd [1993] 2 Lloyd’s Rep 582 [See [1125]. Davy (DOL) engaged National Oilwell (NOW) as a sub-contractor to supply equipment for an off-shore construction project. Subsequently, NOW’s claim for sums owed was met by DOL’s allegation that NOW had delivered defective goods and delayed delivery. DOL’s defence was taken up by its insurers, who, having paid DOL’s losses, exercised rights of subrogation. NOW claimed, among other things, that as a co-assured under the policy it was

entitled to the benefit of a clause in the policy that waived rights of subrogation, or that there was an implied term that DOL could not claim for a loss paid by the insurers. The waiver of subrogation clause was in these terms: ‘Underwriters agree to waive rights of subrogation against any Assured and any person, company or corporation whose interests are covered by this policy and against any employee, agent or contractor of the Principal Assureds or any individual, agent, firm affiliate or corporation for whom the Principal Assureds may be acting or with whom the Principal Assureds may have agreed prior to any loss to waive subrogation, including but not limited to helicopters, supply boats etc, existing installation(s) and tugs and/or insurers. The foregoing shall not apply in respect of operations not connected with the project.’] Colman J: ‘In determining whether and, if so, to what extent, the benefit of the waiver clause is available to NOW, it is important to bear in mind the nature of the contract of insurance to which, having regard to the issue which I have already decided, NOW was a party. That contract insured NOW in respect of all risks for loss and damage to the equipment to be delivered under the agreement up to the time of delivery to DOL and the period of the policy extended to the moment of time when the last item of equipment was indeed delivered. The scope of the risk insured was, however, loss of or damage to such equipment up to delivery. Thus the underwriters were off risk in respect of any item of equipment once it had been delivered to DOL, albeit the policy continued to protect NOW in respect of items of equipment not yet delivered. If there were no

waiver clause and, subsequent to delivery of item X, DOL sustained loss and damage caused by that item of equipment, there would be nothing to stop DOL’s insurers by way of subrogation claiming from NOW the amount in which they had indemnified DOL. It would be nothing to the point that not all the equipment had yet been delivered under the contract. NOW would simply not have been insured by the policy in respect of that loss. It follows that if the effect of the waiver clause would be to preclude DOL’s insurers from pursuing by subrogation postdelivery claims which but for the waiver clause would not arise out of losses insured for the benefit of NOW under the policy, this would place NOW in exactly the same position vis-à-vis insurers as regards such claims as if those losses had been fully insured under the policy. In effect the waiver clause would extend the scope of the insurance to cover losses which were never actually insured for the benefit of NOW. This gives rise to the question whether, as a matter of construction of the policy, if the provisions to the contrary clause limit the cover available to a sub- contractor to a scope less than the full scope provided by the policy to DOL, the waiver clause has the effect of protecting the subcontractor against subrogated claims for losses which, so far as that sub-contractor is concerned, were uninsured by that policy. Such a consequence would indeed be remarkable. The policy would limit the cover with one hand and indirectly by waiver of subrogation remove the limit by another hand. In my judgment the waiver of subrogation clause by the words: “…against any Assured and any person, company or corporation whose interests are covered by this policy…”

confines the effect of the waiver to claims for losses which are insured for the benefit of the party claimed against under the policy. In other words one does not qualify for the benefit of the waiver clause merely by being a party to the contract of insurance. The benefit is only available for

insured losses. Thus where the “provisions to the contrary” clause limits the interests insured, it is only in respect of losses that fall within that party’s insured interest that the waiver clause operates. It may be objected that if that is the only effect of the clause it is doing no more than giving effect to what has been held in Petrofina (UK) Ltd v Magnaload Ltd [1984] QB 127 and Stone Vickers Ltd v Appledore Ferguson Shipbuilders Ltd [1991] 2 Lloyd’s Rep 288 to be the automatic consequence of the sub-contractor being co-assured in respect of losses on the basis of which underwriters attempt a subrogated claim, namely to preclude the bringing by underwriters of such a claim by reason of circuity of action or of an implied term to that effect. Such an argument is not compelling. I adhere to the view which I expressed in my judgment in the Stone Vickers case at p 302 where I sought to explain the basis of a subrogation defence in the following way: “Where a policy is effected on a vessel to be constructed and it is expressed to be for the benefit of sub-contractors as co-assured, if a particular sub-contractor negligently causes loss of or damage to the whole or part of the vessel which has been insured under the policy and the subcontractor has an insurable interest in the vessel, it is not open to underwriters who have settled the insured shipbuilders’ claim to exercise rights of subrogation in respect of the same loss and damage against the coassured sub-contractor. To do so would be completely inconsistent with the insurer’s obligation to the co-assured under the policy. The insurer would in effect be causing the assured with whom he had settled to pursue proceedings which if successful would at once cause the co-assured to sustain a loss arising from loss or damage to the very subject-matter of the insurance in which that co-assured has an insurable interest and a right of indemnity under the policy. In my judgment so inconsistent with the insurer’s

obligation to the co-assured would be the exercise of rights of subrogation in such a case that there must be implied into the contract of insurance a term to give it business efficacy that an insurer will not in such circumstances use right of subrogation in order to recoup from a co-assured the indemnity which he has paid to the assured. To exercise such rights would be in breach of such a term. In such a case the law recognizes the rights of the co-assured by enabling him to rely on his rights under the policy by way of defence in the proceedings which the insurers have caused to be commenced in breach of their implied obligation under the policy. This is an effective means of enforcing the coassured’s rights and makes it unnecessary for him to join the insurers as third parties in the action.” Given that, if the parties had not inserted an express waiver of subrogation, such a term would have been implied and such a term would have had the effect of a waiver of subrogation only in respect of losses insured for the benefit of the sub-contractor, it is, in my view, entirely unsurprising that the parties should have inserted a waiver clause in their policy and that its proper construction should give it an effect exactly equivalent to the term which business efficacy would otherwise require to be implied. The argument advanced by Mr Falconer that the waiver clause should be construed to give effect to the commercial purpose of the policy and that it should therefore span the whole scope of cover expressly provided by the policy to DOL, as distinct from NOW, is, in my view, misconceived. Given that on the proper construction of the provisions to the contrary clause the scope of cover provided by underwriters to NOW is limited to the extent which I have held, the commercial purpose of this contract of insurance has to be defined by reference to that limited cover and not by reference to the purpose which other policies of the kind considered by Mr Wannell or the Supreme Court of Canada

[in Commonwealth Construction Co Ltd v Imperial Oil Ltd (1970) 69 DLR (3rd) 558] could be said to have. The meaning of the waiver of subrogation clause cannot therefore be stretched to accommodate a commercial purpose which this particular contract on its proper construction simply does not have. The waiver clause operates consistently with the commercial purpose of the contract if its meaning is confined to the waiver of claims based on losses insured for the benefit of NOW, that is to say, pre-delivery losses, and that is how, in my judgment, it must be construed. It follows that in as much as the subrogated claims advanced against NOW are based on losses arising in relation to particular items of equipment after delivery to DOL of that equipment, the wavier clause does not preclude or provide a defence in respect of such claims. As to Mr Aikens’ point about the absence of authority to DOL to include in the policy a waiver of the width contended for by NOW, this does not arise. In my view, no such waiver was included in the policy for the benefit of NOW. Once the scope of cover procured for NOW was limited by the authority given to DOL or by the provisions to the contrary clause, the effect of the waiver clause in the contract between NOW and the underwriters was as a matter of construction limited in the manner I have described. [His lordship next considered whether insurers could pursue a subrogated claim against a co-assured.] The explanation for the insurers’ inability to cause one coassured to sue another co-assured is that in as much as the policy on goods covers all the assureds on an all risks basis for loss and damage, even if caused by their own negligence, any attempt by an insurer after paying the claim of one assured to exercise rights of subrogation against another would in effect involve the insurer seeking to reimburse a loss caused by a peril (loss or damage even if caused by the assured’s negligence) against which he had

insured for the benefit of the very party against whom he now sought to exercise rights of subrogation. That party could stand in the same position as the principal assured as regards a loss caused by his own breach of contract or negligence. For the insurers who had paid the principal assured to assert that they were now free to exercise rights of subrogation and thereby sue the party at fault would be to subject the co-assured to a liability for loss and damage caused by a peril insured for his benefit. As I said in Stone Vickers, it is necessary to imply a term into the policy of insurance to avoid this unsatisfactory possibility. The implication of such a term is needed to give effect to what must have been the mutual intention (on this hypothesis) of the principal assured and the insurers, as to the risks covered by the policy. On this basis the purported exercise by insurers of rights of subrogation against the co-assured would be in breach of such a term and would accordingly provide the co-assured with a defence to the subrogated claim…I am firmly of the view that the conclusion arrived at by Mr Justice Lloyd in Petrofina was right: an insurer cannot exercise rights of subrogation against a co-assured under an insurance on property in which the co-assured has the benefit of cover which protects him against the very loss or damage to the insured property which forms the basis of the claim which underwriters seek to pursue by way of subrogation. The reason why the insurer cannot pursue such a claim is that to do so would be in breach of an implied term in the policy and to that extent the principles of circuity of action operate to exclude the claim.’

Note: The decision in National Oilwell demonstrates that determining whether the wrongdoer can defend an action by claiming to be a co-insured and the extent

of the benefit that can be claimed depends on the construction of the contract. In Woolwich Building Society v Brown [1996] CLC 625, an insurance to cover a mortgage debt in case the mortgagor defaulted was held to have been entered into for the benefit of the mortgagee alone, even though the premiums were paid by the mortgagor. In The “Yasin” [1979] 2 Lloyd’s Rep 45, Lloyd J said: ‘In my judgment, the reason why an insurer cannot normally exercise a right of subrogation against a co-assured rests not on any fundmental principle relating to insurance, but on ordinary rules about circuitry.’

In Co-operative Retail Services Ltd v Taylor Young Partnership [2002] Lloyd’s Rep IR 555 (HL), Lord Hope rejected this approach and said that the question was simply, ‘what does the contract provide?’ [1213] Mark Rowlands Ltd v Berni Inns [1986] QB 211 (CA) [MR let premises to BI. MR promised to keep the premises insured against fire and BI promised to recompense MR for the premiums. The lease relieved BI of repairing obligations if the premises were destroyed by fire and MR promised to re-instate the premises with the insurance moneys. The premises were destroyed by a fire caused by BI’s negligence. MR reinstated the premises with funds provided by their insurers, who then sought to recover this money from BI. The Court of Appeal held that MR and BI were not co-insured, but the insurance was effected

by MR for the BI’s benefit. The intention of MR and BI was that MR’s loss by fire would be recovered from the insurance and MR would not claim against BI for negligence. Therefore, there was no right to which MR’s insurers could be subrogated in order to recover their payment from BI.] Kerr LJ: ‘Provided that a person with a limited interest has an insurable interest in the subject-matter of the insurance — an issue to which I turn in a moment in relation to the circumstances of the present case — there is no principle of law which precludes him from asserting that an insurance effected by another person was intended to enure for his benefit to the extent of his interest in the subject matter, whether the insurable interest of the person effecting the insurance be upon the whole of the subject-matter or also only to the extent of a limited interest in it. Illustrations of relationships which may give rise to this consequence are those of bailee and bailor and mortgagee and mortgagor. I do not see why the relationship between landlord and tenant should not be capable of giving rise to the same consequence…’

[1214] Sutton v Jondahl 532 P2d 478 (Court of Appeals of Oklahoma, 1975) Brightmire J: ‘Basic equity and fundamental justice upon which the equitable doctrine of subrogation is established requires that when fire insurance is provided for a dwelling it protects the insurable interests of all joint owners including the possessory interests of a tenant absent an express agreement by the latter to the contrary. The company

affording such coverage should not be allowed to shift a fire loss to an occupying tenant even if the latter negligently caused it.’

[1215] 56 Associates ex rel Paolino v Frieband 89 F Supp2d 189 (US District Court, Rhode Island, 2000) Torres CJ: ‘There are several reasons why the decisions rejecting Sutton represent the “better reasoned authorities” on the subject. First, an insurance policy is a contract between an insurer and its insured. Bush v Mutual Insur Co 448 A2d 784 (RI 1982) Like any other contract its terms are governed by the provisions of the policy itself. Textron Inc v Casualty and Surety Co 638 A2d 537, 539 (RI 1994), If those terms are clear and unambiguous, they must be applied as written. Malo v Aetna Casualty Surety Co 459 A2d 954, 956 (RI 1983). Thus, a court is not free to rewrite a policy or read provisions into it in order achieve what the court subjectively may believe to be a desirable result. Although a fire insurance policy may name, as insureds, persons other than the policy owner, courts have no authority to insert the names of additional insureds. Nor, as Sutton suggests, does the mere fact that an individual may have an insurable interest in property make that individual an insured under a policy of insurance covering the property. That individual also must be a named insured or must purchase insurance covering his interest. See generally Neubauer v Hostetter, 485 NW2d 87, 89–90 (Iowa 1992) (“To the extent that defendant and her husband also had a property interest in the dwelling, it was not automatically insured under the landlord’s policy.”).

Since an insurance policy is a contract between the insurer and its insured, the tenant cannot become an insured unless the insurer agrees and the policy so provides. Accordingly, a landlord’s use of part of the rent collected from a tenant in order to pay premiums does not make the tenant an insured under the policy. Similarly, notwithstanding Sutton and its progeny (eg, Peterson v Silva 428 Mass 751, 704 NE2d 1163, 1166 (1999)) (“The reasonable expectation of the defendants, and all tenants, is that their rent includes the landlord’s cost for fire insurance, and that any damage to the property from fire is covered by that insurance.”); Cascade Trailer 749 P2d at 766 (“[T]he issue concerns the parties’ reasonable expectations. Where the landlord has secured fire insurance covering the leased premises, the tenant can reasonably expect the insurance to cover him as well, unless the parties have specifically agreed otherwise.”), a tenant’s expectation that the landlord will obtain insurance covering the tenant also is insufficient to make the tenant an insured. In such cases, the landlord’s failure to obtain the insurance might render it liable to the tenant for losses that would have been covered by the policy; or, it might bar the landlord from suing the tenant for what would have been Insured losses incurred by the landlord. However, neither the tenant’s expectations nor the unilateral action of the landlord giving rise to those expectations can make a, tenant an insured under a policy issued by the landlord’s insurer. Furthermore, if one accepts Sutton’s proposition that a tenant becomes a coinsured under a landlord’s policy, the tenant would be entitled to a portion of any proceeds payable under the policy. However, it is difficult to envision how those proceeds would be apportioned, especially since the amount payable is determined by the repair or replacement cost of the building itself rather than any occupancy interest of tenants who are not even named in the policy. The solution suggested by one court is to treat

the tenant as a co-insured for the purpose of determining amenability to a subrogation suit, but not for the purpose of determining entitlement to the policy proceeds. Capri 705 P2d at 661 (“[T]he tenant is, for the limited purpose of defeating an insurer’s subrogation claim, an implied coinsured of the landlord.”) (emphasis added). However, there does not appear to be any principled basis for such inconsistent treatment. The wish to achieve a desired result cannot justify arbitrary distinctions or override well established principles of contract law. In short the “Sutton doctrine” is inconsistent with the better reasoned cases that reject the notion that a tenant automatically becomes a co-insured under a landlord’s insurance policy. The “Sutton doctrine” also would be a radical departure from well-established principles of Rhode Island law. Under Rhode Island law, an insurance policy is construed like any other contract…If the terms of the policy are unambiguous, a court must apply them as written and may not read into the policy provisions that are not there. See Malo, 459 A2d at 956. Moreover, Rhode Island law recognises the right of an insurer that pays a loss incurred by its insured to bring a subrogation action against a third party responsible for the loss. Lombardi v Merchants Mutual Insur Co 429 A2d 1290, 1291 (RI 1981). Finally, under Rhode Island law, tenants, like any other persons, generally may be held responsible for the consequences of their negligence [he cited various legislative provisions in support for this proposition].’

[1216] DiLullo v Joseph 792 A2d 819 (Supreme Court of Connecticut, 2002) Borden J:

‘On appeal, the plaintiff claims that the trial court improperly rendered summary judgment for the defendant because: (1) contrary to the trial court’s conclusion, a tenant is not an implied co-insured of a landlord in the absence of an express agreement to the contrary; (2) whether such a relationship exists between a landlord and tenant must be determined by examining the parties’ intent, as gleaned on a case-by-case basis from their lease, if any, and their insurance policies; (3) the court improperly declined to consider the evidence presented to it regarding the parties’ intent in determining whether they were coinsureds; and (4) the court should have inquired into the fact of the parties’ intent regarding whether such a relationship existed between them. We agree with the trial court that, in the absence of an express agreement between the parties covering the question, there is no right of subrogation on the part of a landlord’s fire insurer against a tenant of the landlord’s premises. We reach this conclusion, however, by way of a different route from that of the trial court. We first note that the precise issue we must resolve is: what should be the rule of law that governs in the typical default situation? That is, we recognize that tenants and landlords are always free to allocate their risks and coverages by specific agreements, in their leases or otherwise. The question posed by this appeal, however, is what the appropriate default rule of law should be where, as here, the parties have not made such an agreement. Our strong public policy against economic waste, and the likely lack of expectations regarding a tenant’s obligation to subrogate his landlord’s insurer, lead us to conclude that, as a default rule, no such right of subrogation exists. At the outset, we note that there is a split of authority on this question among other jurisdictions. The leading case for the proposition that there is no right of subrogation, in the absence of a specific agreement to the contrary, is Sutton v

Jondahl 532 P2d 478, 482 (Okla App 1975). What came to be known as the Sutton rule is based on the reasoning that the tenant is deemed to be a coinsured of the landlord because: (1) both parties have an insurable interest in the premises, the landlord as owner, and the tenant as possessor, of the fee; and (2) the tenant’s rent presumably includes some calculation of the landlord’s fire insurance premium. Id. The majority of courts, including the trial court in the present case, have generally adhered to the rule in Sutton, either on its same or different reasoning…In addition, Judge Keeton and Professor Widiss endorse the Sutton result, if not its rationale. “The possibility that a lessor’s insurer may proceed against a lessee almost certainly is not within the expectations of most landlords and tenants unless they have been forewarned by expert counseling. When lease provisions are either silent or ambiguous in this regard — and especially when a lessor’s insurance policy is also silent or ambiguous — courts should adopt a rule against allowing the lessor’s insurer to proceed against the tenant.” R Keeton & A Widiss, Insurance Law (1988) § 4.4(b), pp 340–41. A minority of courts, however, has criticised the Sutton rule and has declined to follow it, adopting a case-by-case analysis instead…A leading treatise on insurance law also has found fault with the Sutton rationale, noting that “the fact both parties had insurable interests [in the premises] does not make them co-insureds. The insurer has a right to choose whom it will insure and it did not choose to insure the lessees, and under this holding the lessee could have sued the insurer for loss due to damage to the realty, eg loss of use if policy provides such coverage.” AJ Appleman & J Appleman, Insurance Law and Practice (Cum Sup.2001) § 4055, pp 131–32 n 86. Appleman has acknowledged, however, that the “[c]ases following Sutton have at least impliedly restricted the co-insurance relationship to one limited solely to the purpose of prohibiting subrogation.” Id.

We agree with these criticisms of the Sutton rationale, as a matter of the general principles of insurance and contract law. Thus, we agree that, under traditional rules of insurance law, a tenant is not a coinsured on his landlord’s fire insurance policy simply because he has an insurable interest in the premises and pays rent. We also agree with the plaintiff that, as a matter of the traditional rules of contract law, whether subrogation would or would not apply ordinarily would depend, in large part, on a case-by-case analysis of the language of the insurance policies and leases involved. In accordance with the weight of authority, however, we conclude that the Sutton result is sound as a matter of subrogation law and policy, and that those considerations outweigh the criticisms and the usual rules of insurance and contract law. Our decision is founded, in large part, upon the principle that subrogation, as an equitable doctrine, invokes matters of policy and fairness. See Home Owners’ Loan Corp v Sears, Roebuck & Co 123 Conn 232, 238, 193 A 769 (1937) (“[s]ubrogation is a doctrine which equity borrowed from the civil law and administers so as to secure justice without regard to form or mere technicality”…). One such policy implicated by the issue presently before us is that disfavoring economic waste…This strong public policy convinces us that it would be inappropriate to create a default rule that allocates to the tenant the responsibility of maintaining sufficient insurance to cover a claim for subrogation by his landlord’s insurer. Such a rule would create a strong incentive for every tenant to carry liability insurance in an amount necessary to compensate for the value, or perhaps even the replacement cost, of the entire building, irrespective of the portion of the building occupied by the tenant. That is precisely the same value or replacement cost insured by the landlord under his fire insurance policy. Thus, although the two forms of insurance would be different, the economic interest insured would be

the same. This duplication of insurance would, in our view, constitute economic waste and, in a multiunit building, the waste would be compounded by the number of tenants. See Peterson v Silva, above, 428 Mass at 754, 704 NE2d 1163 (“[i]t surely is not in the public interest to require all the tenants to insure the building which they share, thus causing the building to be fully insured by each tenancy”). We think that our law would be better served by having the default rule of law embody this policy against economic waste, and by leaving it to the specific agreement of the parties if they wish a different rule to apply to their, or their insurers’, relationship. Furthermore, we agree with Judge Keeton and Professor Widiss that, in most instances, neither landlords nor tenants ordinarily expect that the landlord’s insurer would be proceeding against the tenant, unless expert counseling to that effect had forewarned them. R Keeton & A Widiss, above, § 4.4(b), at pp 340–41. Thus, barring subrogation in such a case comports with the equities of most situations.’

Notes: 1. In Reeder v Reeder 348 NW2d 832 (Supreme Court of Nebraska, 1984) it was held that a person, who was not a tenant but only a guest in the home of another and who negligently damaged the home, could not be sued under a right of subrogation. 2. In many US states the courts have been relatively easily persuaded that a person comes within the category of co-insured and, therefore, cannot be sued by the insurer: see Anon, “Extension of the No Subrogation Against Insured Rule” (1977) 56 Nebraska L Rev 765–

82. In Tower Insurance Co Inc v Chang 601 NW2d 848 (Wisconsin Court of Appeals, 1999), a church fire was caused by two young members who had lit a candle in a church restroom while on their way between a service and a confirmation class. The policy covered, ‘Any of your church members, but only with respect to their liability for your activities or activities they perform on your behalf.’ The court held that lighting the candle was a church ‘activity’ and a reasonable person in the position of the members would expect to be covered. This brought the members within the additionalinsured provision in the policy, and, therefore, the insurers were barred from recovering the payment made to the church from those members. 3. The broader view taken by the US courts of who qualifies as a co-insured has, perhaps, prompted some relaxation of the rule that the insurers cannot sue an insured who causes the loss. In a case before the Wisconsin Court of Appeals, it was held that, while the general rule held good, in such cases it would be overridden by the principle that the wrongdoer should be held accountable (Madsen v Threshermen’s Mutual Insurance Company 439 NW2d 607 (1989)). In that case, after the insurers had settled the claim, it was admitted by one coinsured that he had deliberately burnt the building down. The court held that the innocent co-insured was entitled to retain half the

proceeds and the insurers were entitled to an equitable lien for that amount from the arsonist. Cane PJ: ‘Ordinarily, an insurer does not have a right of subrogation or indemnification against its own insured…In this instance, however, adhering to this principle would defeat a purpose of subrogation, which is to ultimately place the loss on the wrongdoer…Here, the wrongdoer and the insured are the same person, Robert. Thus, requiring Robert to reimburse Threshermen would appropriately place the loss on the wrongdoer.’

[1217] Patent Scaffolding Co v William Simpson Construction Co 64 Cal Rptr 187 (California, Court of Appeal, 1967) [The main contractor, Simpson, agreed to obtain fire insurance on any equipment brought on site by a sub-contractor, Patent, but never did so. Patent already had insurance. Fire destroyed the equipment. Patent’s insurers paid on the claim and, using their right of subrogation, sought to sue Simpson for breach of the contract to insure. The court refused because Simpson had not caused the fire and, therefore, the loss was not connected to the breach of the agreement.] Hufstedler J: ‘After Patent was fully compensated for its fire loss, however, could Patent itself have successfully sued Simpson for breach of contract? Patent could recover twice for the same loss only if the “collateral source” rule applies. When

an injured party receives compensation for his losses from a collateral source “wholly independent of the tortfeasor,” such payment generally does not preclude or reduce the damages to which it is entitled from the wrongdoer…Thus, if Patent sued a person whose negligent or wilful act caused the fire which destroyed its property, Patent’s compensation from its insurers would neither diminish nor defeat the damages which it could recover from the tortfeasor…The collateral source rule, however, has not been generally applied in cases founded upon breach of contract, unless the “breach has a tortious or wilful flavor.”…The collateral source rule is punitive; contractual damages are compensatory. The collateral source rule, if applied to an action based on breach of contract, would violate the contractual damage rule that no one shall profit more from the breach of an obligation than from its full performance. An application of the collateral source rule is particularly indefensible in a situation in which the injured party potentially could make a treble recovery: one from his insurer, one from a defendant who has undertaken contractual liability for the loss, and one from the wrongdoer…We conclude that the collateral source rule would be inapplicable in an action brought by Patent for its own benefit after Patent had been paid by the insurers. Patent suffered no uncompensated detriment caused by Simpson’s breach of contract. It was fully paid for its fire loss. It could not recover the cost of the premiums it had paid to the insurers because it did not incur that expense as a consequence of its contract with Simpson or as a result of Simpson’s breach of contract. A breach of contract without damage is not actionable. Damages are not recoverable which are not causally connected with the breach of a contract. …The fact alone that Patent could not recover from Simpson because Patent suffered no loss does not defeat the insurers’ subrogation rights. The insurers’ loss can be

substituted for Patent’s if the insurers’ loss was proximately caused by the act or omission of Simpson or one for whose acts or omissions Simpson was vicariously liable. The most common subrogation action is one brought on behalf of an insurer against a wrongdoer whose wrong caused the loss… Liability of the wrongdoer may, of course, be based not only on a tort, but also upon a breach of contract…so long as there exists the necessary causal relationship between the wrong and the damage…The insurers’ loss was not caused by Simpson’s failure to get insurance or to indemnify Patent. The insurers’ loss was caused by the fire, the very risk which each assumed, and Simpson’s failure to perform its contractual duty had nothing to do with the fire. The California cases, with one exception, have not permitted equitable subrogation to insurers whose losses are not causally related to a breach of duty for which the party to be charged may be liable to the insurer for a loss compensated by the insurers… The language used in these cases is the verbiage of equity. The lack of any causal connection between the defendant’s breach of contract and the insurer’s loss is not specifically articulated, but it is implicit in the discussion of the comparative equities of the parties. The rule in equitable phraseology is this: Where two parties are contractually bound by independent contracts to indemnify the same person for the same loss, the payment by one of them to his indemnitee does not create in him equities superior to the nonpaying indemnitor, justifying subrogation, if the latter did not cause or participate in causing the loss. …Upon the facts in this case no public policy is perceivably served by shifting the entire loss from the insurers to Simpson. The shifting of loss is not a deterrent to wrongdoing, as it may be in cases permitting subrogation against a tortfeasor…Imposition of the loss upon Simpson would be punitive, and punishment is not the objective of

contractual damages…If subrogation were permitted, the insurers who have accepted premiums to cover the very loss which occurred receive a windfall. There is no evidence in this record that the insurers’ acceptance of the risk or their determination of the cost to the insured of the insurance policies was based in any way upon the terms of Simpson’s contract with Patent. The contest is not between two insurance companies, each of which has received premiums for bearing the loss which ultimately occurred, but between insurers and a general contractor who received no independent consideration for the assumption of the risk. The insurers, being in the insurance business, are in a position effectively to spread the risk and to gauge their premiums upon their loss experience. Upon the evidence in the record we are unable to say that Simpson occupies a similar position. We are aware that the denial of equitable subrogation to the insurers compels the insurers to bear the entire loss and that Simpson is relieved of a responsibility which it solemnly assumed. The result appears to reward delay in the payment of just claims because had Simpson first paid, it likewise would be denied equitable subrogation against the insurers. The conclusion in either event does not have the symmetry of perfect justice. The result, however, is not materially different from many other situations in which a person who has suffered a loss for which more than one person is liable may select one from their number to satisfy the obligation, thereby relieving the remaining parties of their liability. For example, had neither the insurers nor Simpson paid, Patent could have sued both and could have levied execution against either without a right of contribution by the other.’

12.4 Insured’s Obligations

Since the insurer who wishes to sue a wrongdoer must do so in the insured’s name, the insured must not act in such a way as to obstruct or compromise the insurer’s ability to pursue the action. [1218] Commercial Union Assurance Company v Lister (1874) 9 LR Ch App 483 (CA) James LJ: ‘…the Master of the Rolls [at first instance], in the course of his judgment, threw out an observation that if the Defendant compromises, he must compromise bonâ fide; but what that is the Master of the Rolls has not determined, and I do not determine. Mr Lister is by this order left free to go on with and to conduct this action. If he does anything in the conduct of the action inconsistent with his duty, whatever that duty may be (which will have to be determined at the hearing of the cause), he will have to make good any loss thereby incurred. If he does nothing else but that which he is clearly entitled to do, having regard to the position he is in, and to the position of the other parties, then he will be liable to nothing. At present he is himself dominus litis, subject to a liability to answer in this Court for anything which, upon the hearing of the cause, should be shewn to be a breach of some equitable obligation or a violation of some equitable duty which has been cast upon him by reason of the circumstances of the case. Upon this I do not at present intend to express any opinion, and I shall leave it exactly where the Master of the Rolls has left it, as a matter to be determined at the hearing of the cause, if it should ever arise.’

Note:

The insured must compensate the insurer for any rights that the insured has relinquished to the extent that the insurer has thereby been prejudiced. See further, West of England Fire Insurance Co v Issacs [1897] 1 QB 227; Napier and Ettrick v Hunter ([1219]). In Hayler v Chapman [1989] 1 Lloyd’s Rep 490 (CA), Mr Hayler’s car was damaged in a collision. His insurers, Beacon, paid him the write-off value of the vehicle. Then, without informing Beacon, Mr Hayler proceeded against Halifax, the insurer of the other motorist, for his uninsured loss, namely the excess on his policy, car hire, phone calls and taxi fares. Meanwhile, Beacon proceeded against Halifax for their own loss and for Halyer’s uninsured losses to be met by the reply that Hayler had been awarded damages in the county court and that, therefore, no further action could be brought in his name. Beacon failed to get the award overturned by the Court of Appeal. Taylor LJ: ‘…before a Court takes the unusual course of setting aside a judgment given after a contested hearing, there would have to be evidence as to the conduct of the parties showing that it was unjust and inequitable for that judgment to stand and thereby bar any additional claim…There is no evidence from the Beacon or the plaintiff to fix the Halifax with any knowledge that this claim was going forward. It is again left to inference and surmise that because the uninsured loss was included in the Beacon’s letter of a claim, the Halifax should have realised that insurer and insured had got their lines crossed and were under a misapprehension. Moreover, there is nothing to show that the Halifax acted so as

deliberately to exploit the misunderstanding between the Beacon and the plaintiff, their insured. They did not, as happened in some reported cases, hasten to settle the plaintiff’s small claim and then tell his insurers that their claim was barred. Whether with or without the involvement of the Halifax, the plaintiff’s claim was fully contested.’

12.5

Distribution Received

of

Compensation

If the insurers have met their liabilities under the policy, they are entitled to exercise their rights of subrogation even though there are other uninsured losses. This does, however, leave the issue of how compensation, which has been received from the wrongdoer, is to be distributed as between the insurer and the insured where there is uninsured loss. [1219] Lord Napier and Ettrick v Hunter [1993] AC 713 (HL) [This case originated in the difficulties experienced in the Lloyd’s insurance market in the 1980s. The insured were members of a Lloyd’s syndicate (‘the names’); the wrongdoer was a managing agent (Outhwaite) who negligently wrote policies without adequate reinsurance cover; and the appellants were insurers (‘the stop loss insurers’). As members of the Outhwaite Syndicate, the names shared the nett premiums and were liable to pay claims under policies issued by Outhwaite on their behalf. The

names sought to insure against part of any loss they might incur as members of the syndicate and, therefore, each name paid a premium to the stop loss insurers for a policy whereby the stop loss insurers agreed to indemnify them for the amount by which the nett underwriting loss exceeded the amount stated as ‘excess’.] Lord Templeman: ‘For purposes of illustration, the arguments in the courts below and in this House assume that for the 1982 year of account a particular hypothetical name suffered a nett underwriting loss of £160,000, that the excess was £25,000, and that the limit was £100,000. On these figures the stop loss insurance paid to the name £100,000 being the fixed amount of the limit (£100,000) which exceeded the excess (£25,000). The names together with other names sued Outhwaite for damages for negligence and breach of duty in respect of, inter alia, the 1982 year of account. Those proceedings were compromised on payment by Outhwaite of £116m. to the respondents Richards Butler as solicitors for the plaintiffs in the action. For the purposes of the illustration it is assumed that included in the sum of £116m. Richards Butler hold £130,000 attributable to the overall ascertained nett loss of £160,000 suffered by the hypothetical name for the 1982 year of account. On these assumptions two problems arise. First how much is payable to the stop loss insurers by way of subrogation? Secondly are the stop loss insurers entitled to be paid the amounts found due to them by way of subrogation out of the damages now held by Richards Butler? The problem must, in my opinion, be solved by assuming that the name insured the first £25,000 of any loss and also insured the excess over £125,000 as well as insuring the £100,000 payable under his policy with the stop loss

insurers. There would then be three insurance policies as follows: (1) a policy for the payment of the first £25,000 of any loss; (2) a policy for payment of the next £100,000 of any loss; (3) a policy for payment of any loss in excess of £125,000. When the name suffered a loss of £160,000 the name received £25,000 under the first policy, £100,000 under the second policy and £35,000 under the third policy. The damages payable by Outhwaite were £130,000. The third insurer is entitled to be the first to be subrogated because he only agreed to pay if the first two insurances did not cover the total loss; accordingly the third insurer must be paid £35,000. The second insurer is entitled to be the second to be subrogated because he only agreed to pay if the first insurance cover proved insufficient; accordingly the second insurer must be paid £95,000. The sum of £35,000 payable by way of subrogation to the third insurer and the sum of £95,000 payable by way of subrogation to the second insurer exhausts the damages of £130,000 received by the name from Outhwaite. There is nothing left to recoup to the second insurer the balance of £5,000 out of the £100,000 he paid under his policy. There is nothing left by way of subrogation for the first insurer in respect of the first £25,000 which he agreed to bear. Under the stop loss insurance the name agreed to bear the first £25,000 loss and any loss in excess of 125,000. In my opinion the name is not entitled to be in a better position than he would have been if he had taken out the three insurances I have mentioned. The name in fact acts as his own insurer for the first £25,000 loss and acts as his own insurer for any loss in excess of £125,000. So the name must pay £95,000 to the stop loss insurers just as he would have been liable to pay £95,000 to the second insurer if he had taken out three policies. In the result, out of the loss of £160,000, the name will have borne the first £25,000 because he agreed with the stop loss insurers that he would

bear that loss. The stop loss insurers having paid £100,000 under the policy will receive back £95,000 by way of subrogation. …In my opinion an insured is not entitled to be indemnified against a loss which he has agreed to bear. I agree therefore with the Court of Appeal that the name must bear the loss to the extent of the excess, namely £25,000. The second question is whether the stop loss insurers have an interest in the moneys held by Richards Butler. For this purpose it may be assumed by way of example that the moneys held by Richards Butler include £130,000 paid by Outhwaite as damages for negligence which inflicted a loss of £160,000 on a name in respect of the 1982 year of account; can the stop loss insurers assert an interest in that sum of £130,000 to the extent of the £95,000 which, as I have indicated, is due to them by way of subrogation? When the hypothetical name suffered a loss of £160,000 as a result of the negligence of Outhwaite, the stop loss insurers were bound to pay and did pay £100,000 under the policy. The stop loss insurers immediately became entitled to be subrogated to the right of the name to sue and recover damages in an action against Outhwaite, albeit that the amount payable to the stop loss insurers by way of subrogation could not be quantified until the action had been concluded and the damages paid. Nevertheless in my opinion the stop loss insurers had an interest in the right of action possessed by the name against Outhwaite. That action, if brought by the name, would be an action for the benefit of the name and for the benefit of the stop loss insurers. Where an insurer has paid on the policy, the courts have recognised the interests of the insurer in any right of action possessed by the insured person which will enable the insurer to claim back the whole or part of the sum which he has paid under the policy. The courts recognise the interests of the insurer by allowing him to sue in the name

of the insured person against the wrongdoer if the insured person refuses to pursue the action. In Randal v Cockran (1748) 1 Ves Sen 98a vessel was insured against loss and the insurance company paid the amount of the insurance when the vessel was captured by the Spaniards. The owner of the vessel became entitled to share in the prize money from the sale of captured Spanish vessels in accordance with a Royal Proclamation. The commission for the distribution of the prize money refused to entertain a claim from the insurer. Lord Hardwicke LC. “was of opinion, that the plaintiffs had the plainest equity that could be. The person originally sustaining the loss was the owner; but after satisfaction made to him, the insurer. No doubt, but from that time, as to the goods themselves, if restored in specie, or compensation made for them, the assured stands as a trustee for the insurer, in proportion for what he paid…” In Blaauwpot v Da Costa (1758) 1 Ed 130 a ship insured for £1,636 was seized by the Spaniards and the insurance company paid the sum insured. Subsequently prize money amounting to £2,050 18s 6d was paid to the executors of one of the former owners of the vessel. The executors were ordered to pay the sum of £1,636 7s 3d to the insurers in accordance with the following judgment of the Lord Keeper, Lord Northington, at p 131: “I am of opinion that upon the policy, and the peril happening, and the payment of the money by the underwriters, the whole rights of the assured vested in them. The assured had this right of restitution vested in them against the Spanish captors, which was afterwards prosecuted by the Crown by reprisals. Satisfaction having been made in consequence of that capture, I think the

plaintiffs are entitled to that benefit; and that it was received by the executors…in trust for them.” In Mason v Sainsbury (1782) 3 Doug 61 a house had been insured against damage and the insurance company paid under the policy when damage was caused by the riots of 1780. The insurance company brought an action under the Riot Act 1714 (1 Geo 1, c 5) against the local authority. The insurance company sued in the plaintiff’s name and with his consent and for the benefit of the insurance company. Lord Mansfield said, at p 64, that the contract of insurance was an indemnity and that “Every day the insurer is put in the place of the insured.” In Yates v White (1838) 1 Arn 85 the owner of a vessel sued the defendant for damaging his ship by collision. The defendant claimed to deduct from the amount of damages the sum which the plaintiff had received from his insurers in respect of such damage. The claim was rejected. In White v Dobinson (1844) 14 Sim 273 the ship Diana was insured against damage. After a collision the insurers paid £205 in respect of the damage. The owner of the vessel, Hicks, was awarded damages of £800 against a defendant who was held liable for the collision. Sir Lancelot Shadwell V-C granted an injunction restraining the insured person Hicks from receiving and the wrongdoer Dobinson from paying the sum of £800 in respect of damages without first paying or providing for the sum of £205 in respect of which the insurers were entitled to be subrogated. On appeal (White v Dobinson (1844) 116 LTOS 233) Lord Lyndhurst LC said: “What is an insurance but a contract of indemnity? Then Hicks having received a full satisfaction under the award, what right has he to retain money received from the insurance office as an indemnity for damage?…If Hicks had received an indemnity before the payment of the money by

the company, it would clearly have been contrary to equity that he should retain that money. Park on Marine Insurances [8th edn (1842)] says, that a contract to insure is one of indemnity only, and that the insured shall not receive double compensations for a loss; but in case the loss has been paid, and the insured afterwards recovers the amount of damages from another source, the insurer shall stand in his place to the extent of the sum they have paid.” Hicks then argued that the plaintiff had no remedy in equity and that his only course was an action in a court of law for money had and received. This argument was rejected and the Lord Chancellor said: “Here the company have paid for a loss, for which the insured afterwards obtains full satisfaction, and it is contrary to equity that he should retain the money. The underwriters have a claim upon the fund awarded, and are entitled in some shape or other to recover back the money they have paid.” The injunctions were accordingly upheld. This is authority for the proposition that if application is made to the court before the wrongdoer has paid damages in respect of which an insurer is entitled to subrogation, the court will not allow the damages to be paid over without satisfying the claims of the insurer. In Commercial Union Assurance Co v Lister (1874) LR 9 ChApp 483 the owner of a building insured it for £33,000 against fire but not for the full value. The building was burned by what was said to be the negligence of the servants of a municipal corporation and suffered damage estimated at £56,000. The owner brought an action for damages against the corporation. It was held by the Court of Appeal upholding Sir George Jessel MR that the owner undertaking to sue for the whole amount of damage would

be allowed to conduct the action without interference from the insurers, but would be liable for anything done by him in violation of any equitable duty towards the insurers. In the course of his judgment Sir George Jessel MR had said, at p 484n: “The total amount of the loss is admitted to exceed very largely the total amount of the insurances. It is alleged that the fire was caused…by the act of the corporation of Halifax…and that the carelessness was of such a kind as to render the corporation liable for the whole of the loss. In that state of things the insurance company or companies is or are willing to pay the amount of the insurance, and they say that, having paid that amount (they pay of course by way of indemnity), if the assured obtains from the corporation of Halifax a sum larger than the difference between the amount of the insurance and the amount of the loss, he is a trustee for that excess for the insurance company or companies — a proposition which I take to be indisputable.” [His lordship then quoted from the judgment of Brett LJ in Castellain v Preston, see [1201]] Clearly Brett LJ considered that an insurer was subrogated to any right of action subsisting when the insurer paid under the policy. In In re Miller, Gibb & Co Ltd [1957] 1 WLR 703 the Export Credits Guarantee Department of the Board of Trade issued to a company a policy of insurance for 90 per cent of the amount of any loss sustained in respect of goods sold to Brazil in the event of local regulations preventing payment or a transfer of payment from the buyer to the company. The buyer paid in Brazil into a bank for the account of Martins Bank Ltd who were acting for the company. Transfer of this payment was prevented by Brazilian currency exchange regulations and the Department accordingly paid 90 per cent under the terms of the indemnity policy. The

company was ordered to be wound up. The Department gave notice to Martins Bank of their claim to be subrogated to the rights of the company with respect to the payment from Brazil when received. In January 1956 the bank received the full purchase price from Brazil and the Board of Trade claimed 90 per cent. Wynn-Parry J ordered the liquidator of the company to execute all such documents and do all such things necessary to enable the Department to obtain from Martins Bank 90 per cent of the sum which had been received by the bank. This case is indistinguishable from the present. In Yorkshire Insurance Co Ltd v Nisbet Shipping Co Ltd [1962] 2 QB 330 a vessel was insured for £72,000 and became an actual total loss. The insurers paid £72,000. The assured brought proceedings in Canada for the loss of the vessel and the defendants paid to the assured in Canada 336,000-odd Canadian dollars then worth £75,000-odd. The pound was devalued and when the damages were transmitted to London they were worth £127,000. Diplock J held that the doctrine of subrogation only entitled the insurers to recoupment of the £72,000 which they had paid. Diplock J referred to the doctrine of subrogation in these terms, at pp 339–41: “The doctrine of subrogation is not restricted to the law of insurance. Although often referred to as an ‘equity’ it is not an exclusively equitable doctrine. It was applied by the common law courts in insurance cases long before the fusion of law and equity, although the powers of the common law courts might in some cases require to be supplemented by those of the court of equity in order to give full effect to the doctrine; for example, by compelling an assured to allow his name to be used by the insurer for the purpose of forcing the assured’s remedies against third parties in respect of the subject matter of the loss…The expression ‘subrogation’ in relation to a contract of marine insurance is thus no more than a convenient way of

referring to those terms which are to be implied in the contract between the assured and the insurer to give business efficacy to an agreement whereby the assured in the case of a loss against which the policy has been made shall be fully indemnified, and never more than fully indemnified…In my view the doctrine of subrogation in insurance law requires one to imply in contracts of marine insurance only such terms as are necessary to ensure that, notwithstanding that the insurer has made a payment under the policy, the assured shall not be entitled to retain, as against the insurer, a greater sum than what is ultimately shown to be his actual loss…Thus, if after payment by the insurer of a loss that loss, as a result of an act of a third party, is reduced, the insurer can recover from the assured the amount of the reduction because that is the amount which he, the insurer, has overpaid under the contract of insurance. This sum he can recover at common law without recourse to equity, as money had and received…the duty of the assured to take proceedings to reduce his loss and the correlative right of the insurer to require him to do so was a contractual duty. The remedy for its breach, by compelling the assured to allow an action to be brought in his name, was an equitable remedy in aid of rights at common law, and was alternative to the common law remedy of recovering damages for the breach of the duty…” In Hobbs v Marlowe [1978] AC 16, 39 Lord Diplock said: “For my own part I prefer to regard the doctrine of subrogation in relation to contracts of insurance as having its origin at common law in the implied terms of the contract and calling for the aid of a court of equity only where its auxiliary jurisdiction was needed to compel the assured to lend his name to his insurer for the enforcement of rights and remedies to which his insurer was subrogated: see Yorkshire Insurance Co Ltd v Nisbet Shipping Co Ltd. But the

practical effects of the doctrine of subrogation upon the rights and remedies of insurer and assured are similar in many respects to the effect of an equitable assignment of a chose in action…” Thus Lord Diplock, far from deciding that a court of equity could not lend its aid to compel the assured to direct that the insurer be recouped under the doctrine of subrogation out of the damages recovered from the wrongdoer, equated the right of the insurer to that of the assignee of an equitable interest, a right which equity will of course enforce. It may be that the common law invented and implied in contracts of insurance a promise by the insured person to take proceedings to reduce his loss, a promise by the insured person to account to the insurer for moneys recovered from a third party in respect of the insured loss and a promise by the insured person to allow the insurer to exercise in the name of the insured person rights of action vested in the insured person against third parties for the recovery of the insured loss if the insured person refuses or neglects to enforce those rights of action. There must also be implied a promise by the insured person that in exercising his rights of action against third parties he will act in good faith for the benefit of the insured person so far as he has borne the loss and for the benefit of the insurer so far as he has indemnified the insured person against the insured loss. My Lords, contractual promises may create equitable interests. An express promise by a vendor to convey land on payment of the purchase price confers on the purchaser an equitable interest in the land. In my opinion promises implied in a contract of insurance with regard to rights of action vested in the insured person for the recovery of an insured loss from a third party responsible for the loss confer on the insurer an equitable interest in those rights of action to the extent necessary to

recoup the insurer who has indemnified the insured person against the insured loss. In the hypothetical case under consideration, the intervention of equity is required to ensure that the insured person exercises his right of action against the wrongdoer in good faith and that the insurer is recouped out of the damages recovered from the wrongdoer. The stop loss insurer is out of pocket to the amount of £100,000 from the time that he pays, as he must pay, £100,000 to the name immediately the loss has been suffered. The stop loss insurer is entitled to be recouped £95,000 as soon as the damages of £130,000 are available from the wrongdoer. The name cannot delay or frustrate recoupment without inflicting harm on the insurer who remains out of pocket to the extent of £100,000 until he is recouped. The name cannot make use of the damages payable by the wrongdoer and available for recoupment of the stop loss insurers without the name receiving a benefit or advantage to which he is not entitled. When I asked why the names were defending these present proceedings, your Lordships were blandly informed that the names wished to benefit their “cash flow” by making use of all the damages payable by Outhwaite and deferring recoupment until each stop loss insurer was able to obtain a judgment against each name for money had and received. The stop loss insurers were not in a position to sue the name to whom they had paid £100,000 until the action against Outhwaite resulted in judgment or compromise which included £130,000 for the insured loss and the damages of £130,000 had been paid to the name; they were even then not in a position to sue the name until the amount which the stop loss insurers were entitled to recoup under the doctrine of subrogation had been ascertained and calculated. There are 246 names, some of whom are resident in the United States of America and elsewhere abroad. In order to succeed in an action for money had and received stop loss insurers might be obliged

to pursue litigation at considerable expense and subject to considerable delay in a country which knows nothing of an action for money had and received or does not recognise the doctrine of subrogation or confines its civil litigation to the tender mercies of juries who are unsympathetic towards insurers. By the time that the stop loss insurers ascertain that they are entitled to be repaid the sum of £95,000 and no more and no less under the doctrine of subrogation and bring and succeed in a claim against the hypothetical name to be paid £95,000, whether judgment for that sum be obtained at home or abroad, the name, having had and received £100,000 from the stop loss insurers, may not be in a position to pay back £95,000. We were informed and accept that the respondent and representative name Lord Napier and Ettrick is a man of honour and substance and will fulfil his obligations although he is not apparently willing to fulfil them until a writ is issued and judgment is obtained against him for money had and received. But no one can answer for the other 245 names. If the stop loss insurers have no equitable remedy in connection with their rights and if a name becomes bankrupt then subrogation is a mockery. Suppose, for example, that a name receives £100,000 from an insurer under a policy, recovers judgment for £130,000 damages from the wrongdoer and the name goes bankrupt before he receives the damages owing £1m and possessing no assets other than assets representing the £100,000 he has received from the insurer and the asset of £130,000 payable by the wrongdoer. In that case, if the argument on behalf of the names is correct, the unsecured creditors of the insured name will benefit by double payment. The stop loss insurers will be in a worse position than an unsecured creditor because the insurers could not resist payment under the policy whereas an unsecured creditor may choose whether to advance moneys or not. In the case of the bankruptcy of

the name, the right of the insurer to subrogation will be useless unless equity protects that right. Saville J and the Court of Appeal held that the stop loss insurers were confined to their remedy for money had and received. The damages must first be distributed to the names. The stop loss insurers must then agree or determine by application to the court the amount due to them respectively and must then bring proceedings for money had and received against each of the names. All the authorities which indicated that an insurer who pays on the policy and is entitled to recoupment by way of subrogation has an equitable interest in the right of action of the insured person against a wrongdoer and an equitable interest in the damages payable by the wrongdoer were said not to be binding on the courts…I am not prepared to treat authorities which span over two centuries in a cavalier fashion. The principles which dictated the decisions of our ancestors and inspired their references to the equitable obligations of an insured person towards an insurer entitled to subrogation are discernible and immutable. They establish that such an insurer has an enforceable equitable interest in the damages payable by the wrongdoer. The insured person is guilty of unconscionable conduct if he does not provide for the insurer to be recouped out of the damages awarded against the wrongdoer. Equity will not allow the insured person to insist on his legal rights to all the damages awarded against the wrongdoer and will restrain the insured person from receiving or dealing with those damages so far as they are required to recoup the insurer under the doctrine of subrogation. Where the insured person has been paid policy moneys by the insurer for a loss in respect of which the insured person recovers damages from a wrongdoer the insured person is guilty of unconscionable conduct if he does not procure and direct that the sum due to the insurer shall by way of subrogation be paid out of the damages.

It is next necessary to consider how equity copes with such unconscionable conduct. Saville J and the Court of Appeal appear to have thought that equity can only interfere by creating a trust fund held in trust by trustees for different beneficiaries in different shares, the trustees being burdened with administrative and investment duties, the trustees being liable for all the duties imposed on trustees but being free from liability if the trust fund is lost without negligence. I agree that if this were the only method of protecting the rights of an insurer the practical disadvantages would be fearsome. Fortunately, equity is not so inflexible or powerless. In order to protect the rights of the insurer under the doctrine of subrogation equity considers that the damages payable by the wrongdoer to the insured person are subject to an equitable lien or charge in favour of the insurer. The charge is imposed by equity because the insurer, once he has paid under the policy, has an interest in the right of action against the wrongdoer and an interest in the establishment, quantification, recovery and distribution of the damages awarded against the wrongdoer. It would be unconscionable for the insured person, who has received £100,000 from the insurer, to put damages of £130,000 into his own pocket without providing for the recoupment of the insurer who only contracted to indemnify the insured person. The insurer can give notice to the wrongdoer of his equitable charge. When the wrongdoer is ordered or agrees to pay £130,000 and has notice of the rights of the insurer to subrogation, the wrongdoer can either pay the damages into court or decline to pay without the consent of both the insured person and the insurer. It would be the duty of the insured person to direct the wrongdoer to pay £95,000 of the damages to the insurer in recoupment and to pay the balance of £35,000 to himself. The equitable charge in favour of the insurer is enforceable against the damages ordered to be paid; that charge can be enforced so long as

the damages form an identifiable separate fund. If, in the present case, Richards Butler had distributed the damages to the names before the stop loss insurers issued proceedings or notified Richards Butler of their equitable charge, the stop loss insurers would have been reduced to exercising their rights to sue the names for money had and received. In the present case damages of £116m are in a separate fund held by Richards Butler on behalf of the names albeit that the damages in the fund also include moneys held on behalf of other names and other insurers. For the reasons I have indicated it would be unconscionable for the names to take their shares of the damages without providing for the sums due to the stop loss insurers to be paid out of those damages. The equitable charge still affects the damages and affects Richards Butler who hold the damages with notice of the charge. It is true that it may not be possible to distribute the damages between the stop loss insurers and the names at once because the amounts due to the names as opposed to other names may still be uncertain and because the amounts due to the stop loss insurers in any particular case by way of subrogation may still be uncertain. These uncertainties are due to the fact that losses of Lloyd’s underwriters surface and are quantified in some cases many years after the relevant year of account. The calculations are also complicated by the fact that the damages of £116m are in compensation of claims extending over different years of account with different names and insurers and with insurance policies containing different provisions. Delay in distributing the damages cannot be blamed on the stop loss insurers. Delay is as much a disadvantage to the stop loss insurers as it is to the names. It is in the interests of everybody that the damages shall be distributed as soon as possible. Interim distributions can be made in favour of those names and stop loss insurers whose rights and

liabilities have been or are now capable of being calculated with certainty. If necessary the court will decide how much can now be distributed. Any reserves for uncertain events can be invested in joint names for the benefit of the name and the stop loss insurers concerned. In the result I would allow the appeal by the stop loss insurers against the refusal of Saville J and the Court of Appeal to grant any relief in equity against the names and Richards Butler. In my opinion the stop loss insurers are entitled to injunctions restraining Richards Butler from paying and each name from receiving any part of the damages of £116m now held by Richards Butler without first providing or paying out of the damages payable to the name the amounts which have been or shall be found to be due from that name to the stop loss insurers by way of subrogation. I would dismiss the cross-appeal by the names against the declaration made by the Court of Appeal and make a declaration in these terms: “That, when determining the amount which stop loss insurers are entitled to claim in respect of the settlement moneys, the stop loss insurers are entitled to be reimbursed any indemnity paid by them to an assured before that assured is fully indemnified by applying his share of the settlement moneys to a loss occurring below the excess in that assured’s policy.” Since drafting this speech I have read in draft the speech to be delivered by my noble and learned friend, Lord Goff of Chieveley. He agrees that the doctrine of subrogation confers on the insurer an equitable proprietary lien or charge on the moneys recovered by the insured person from a third party in respect of the insured loss. I agree that in the circumstances it is not now necessary to decide whether the equitable lien or charge attaches also to the rights of

action vested in the insured person to recover from a third party. I have expressed the view that the doctrine of subrogation does apply in those circumstances but in any future case, if the point becomes material, that view may require reconsideration in the light of further research. Subject to this observation I agree with the views expressed by Lord Goff and I also agree with the speeches to be delivered by my noble and learned friends, Lord Jauncey of Tullichettle and Lord Browne-Wilkinson.

Lord Goff: [having reviewed the case-law, his lordship continued] ‘an important feature of these cases is that the principle of subrogation in the law of insurance arises in a contractual context. It is true that in some cases at common law it has been described as arising as a matter of equity. Thus in Burnand v Rodocanachi Sons & Co, 7 App Cas 333, 339, Lord Blackburn described it simply as “an equity.” Furthermore, it has not been usual to express the principle of subrogation as arising from an implied term in the contract. Even so it has been regarded, both at law and in equity, as giving effect to the underlying nature of a contract of insurance, which is that it is intended to provide an indemnity but no more than an indemnity. Not only does this principle inform the judgments of the Court of Appeal in the leading case of Castellain v Preston, 11 QBD 380, but it underlies Lord Lyndhurst LC’s judgment in White v Dobinson, 116 LTOS 233. In so far as the principle requires the payment of money, it could no doubt be formulated as an implied term, to which effect could have been given by the old action for money had and received. But I do not see why the mere fact that the purpose of subrogation in this context is to give effect to the principle of indemnity embodied in the contract should preclude recognition of the equitable proprietary right, if justice so requires. If I search for a parallel, the closest analogy is perhaps to be found in

the law of agency in which, although the relationship between principal and agent is governed by a contract, nevertheless the agent may be held in certain circumstances to hold money, which he has received from a third party in his capacity as agent, as trustee for his principal. It is by no means easy to ascertain the circumstances in which a trusteeship exists; but, in a valuable discussion in Bowstead on Agency, 15th edn (1985), pp 162–63, Professor Francis Reynolds suggests that it is right to inquire “whether the trust relationship is appropriate to the commercial relationship in which the parties find themselves; whether it was appropriate that money or property should be, and whether it was, held separately, or whether it was contemplated that the agent should use the money, property or proceeds of the property as part of his normal cash flow in such a way that the relationship of debtor and creditor is more appropriate.” He also suggests that “a central question, perhaps too often overlooked (because not directly an issue), is whether the rights of the principal are sufficiently strong, and differentiable from other claims, for him to be entitled to a prior position in respect of them on the agent’s bankruptcy.” I have little doubt that the distinguished judges who decided the cases in the line of equity authority to which I have referred must have considered that money received by an assured from a third party in reduction of a loss paid by an insurer should not be treated as available for the assured’s normal cash flow, and further that the rights of the insurer to such money were sufficiently strong to entitle the insurer to priority in the event of the assured’s bankruptcy, as was

indeed held by Wynn-Parry J in In re Miller, Gibb & Co Ltd [1957] 1 WLR 703. I for my part can see no good reason to depart from this line of authority. However, since the constitution of the assured as trustee of such money may impose upon him obligations of too onerous a character (a point which troubled Saville J in the present case), I am very content that the equitable proprietary right of the insurer should be classified as a lien, as proposed by my noble and learned friend, Lord Templeman, and indeed as claimed by the insurer in White v Dobinson, 14 Sim 273 itself. Indeed a lien is the more appropriate form of proprietary right in circumstances where, as here, its function is to protect the interest of the insurer in an asset only to the extent that its retention by the assured will have the effect that he is more than indemnified under the policy of insurance. There is one particular problem to which I wish to refer, although, as I understand it, it does not fall to be decided in the present case. Does the equitable proprietary interest of the insurer attach only to a fund consisting of sums which come into the hands of the assured in reduction of the loss paid by the insurer? Or does it attach also to a right of action vested in the assured which, if enforced, would yield such a fund? The point is not altogether easy. I can see no reason in principle why such an interest should not be capable of attaching to property in the nature of a chose in action. Moreover that it should do so in the present context appears to have been the opinion of Lord Blackburn in Simpson & Co v Thomson, 3 App Cas 279, 292–93. On the other hand, cases such as Morley v Moore [1936] 2 KB 359 appear to point in the opposite direction, as perhaps does the decision of Lord Lyndhurst LC in White v Dobinson, 116 LTOS 233 to discharge the injunction as against the owner of the ship at fault in that case. However, since the point was not directly addressed in the argument before your Lordships, I am reluctant to reach any conclusion upon it

without a full examination of the authorities relating to the respective rights and obligations of insurer and assured, especially with regard to the conduct and disposal of litigation relating to causes of action of the relevant kind. I therefore wish to reserve my opinion upon this question, the answer to which I do not regard as necessary for the resolution of the issue which has arisen in the present case. For these reasons, I would allow the appeal.

Lord Jauncey: ‘A name having a policy with an excess of £25,000 and insurers’ liability limited to £100,000 suffers a total loss of £160,000, but receives £100,000 under his policy and later recovers £130,000 in the action. The names argued that the £130,000 fell to be applied as to £ 35,000 to meet the uninsured top slice of the loss, as to £25,000 to meet the initial excess and as to the remaining £70,000 for the benefit of the stop loss insurers. There was no dispute as to the application of £35,000 but the stop loss insurers maintained that the remaining £95,000 should be applied for their benefit leaving them with a liability to the insured of only £5,000. In short the question was whether the names were entitled to recoup themselves out of the recoveries for their initial uninsured £25,000 loss in priority to the stop loss insurers.’

Notes: 1. See J Birds, “Subrogation in the House of Lords” [1993] JBL 294; J Lowry and P Rawlings, Insurance Law: Doctrines and Principles (Oxford, Hart Publishing, 1999), 212–18. 2. It is important to distinguish between losses that are under-insured and losses that are uninsured. In the former the risk is covered but

3.

not to the full amount of the loss. The insured will be their own insurer for the amount by which the actual loss exceeds the insured loss and will have first claim for this amount on any compensation paid by a wrongdoer. Where the loss is uninsured the risk is not covered at all and the interested party (the property owner) is, in effect, their own insurer for the whole amount and will be entitled to the whole of any compensation received. In the event of compensation from the wrongdoer exceeding the payment received from the insurers, the insured, having repaid the amount paid by the insurers, will retain the surplus (Yorkshire Insurance Co Ltd v Nisbet Shipping Co Ltd [1962] 2 QB 330. For the situation in valued policies, where the policy specifies the value of the property in the event of a total loss, see North of England Iron Steamship Insurance Association v Armstrong (1870) LR 5 QB 244). See the critique of the Yorkshire Insurance case in R Keeton & A Widiss, Insurance Law (St Paul, Minn, West Group, 1988), 235n, and their discussion of the different approaches to sharing out money recovered from a wrongdoer (at 233–7). They suggest that there is nothing that might be called ‘a majority or even a prevailing rule’ in the US as to how this should be done. The approaches are (at 234–5): ‘(1) The insurer is to be reimbursed first out of the recovery from the third party for

the full amount of the insurance benefits paid to the insured, and the insured is then entitled to any remaining balance. (2) The recovery from the third party is to be prorated between the insurer and the insured in accordance with the percentage of the total original loss for which the insurer provided indemnification to the insured under the policy. (3) The insured is to be reimbursed first out of the recovery from the third party for any loss that was not covered by insurance, the insurer is then entitled to be reimbursed fully, and the insured is entitled to anything that remains from the amount paid by the third party so that any “windfall” goes to the insured.’ 4. The insurer, who, having exercised rights of subrogation, receives damages in excess of the payment made on the policy, holds that excess on trust for the insured: Lonhro Exports Ltd v Export Credits Guarantee Department [1996] 2 Lloyd’s Rep 649. 5. It is not only cash but also benefits in kind that must be accounted for in calculations as between insured and insurer (Darrell v Tibbits (1880) 5 QBD 560). The insurer is entitled to anything received by the insured that reduces the loss suffered, but this does not include any benefit which, although coming from the wrongdoer, is intended as a gift and not as

compensation for the loss (Burnand Rodocanachi (1882) 7 App Cas 333).

v

[1220] Colonia Versicherung AG v Amoco Oil Co [1995] 1 Lloyd’s Rep 570 Potter J: ‘First and foremost, it does not seem to me that the payment in this case can in law or logic be regarded as equivalent to a “gift”. In Burnand’s case [Burnand v Rodocanachi (1882) 7 App Cas 333)], the intention underlying the payment was of course a matter to be ascertained or inferred from construction of the Act of Congress, ie, the instrument pursuant to which it was paid. The payment was held to be the equivalent of a “gift” for two reasons. First, the plain intention of the Act to compensate for uninsured losses. Secondly, because the Act or instrument pursuant to which the payment was made, was not one in respect of which the payee enjoyed any right of action for enforcement (indeed he was not a party). As Lord Justice Brett stated in Castellain v Preston at p 389: “It was only a gift to which the assured had no right at any time until it was placed in their hands.” The same could plainly be said of the payment in [Merrett v Capitol Indemnity Corporation [1991] 1 Lloyd’s Rep 169]. In that case, there was apparently no instrument or other document to be construed for the purposes of ascertaining the brokers’ intentions, the case being decided on the basis of the arbitrators’ findings as to what those intentions were. In both Burnand’s case and Merrett’s case, the sums paid were truly a gift or windfall so far as the insured was concerned.

The position is wholly different in this case, where the intention underlying the payment to ICI falls to be collected from the wording of the assignment. Such wording reveals a plain intention to compromise disputed claims…those claims being all of ICI’s [the insured] claims against Amoco [the wrongdoer] or any other party…arising out of the transaction. It is equally plain that the settlement of such claims (whether or not they were ultimately valid or legally enforceable and whether or not coupled with an assignment) afforded (a) the reason and (b) ample consideration for the payment. Far from being a windfall, the payment was made pursuant to an enforceable agreement concerning ICI’s loss and can in no sense be regarded as a “gift”.’

12.6 Defences Available to the Wrongdoer As might be expected in view of the nature of the subrogated action, a wrongdoer may use any defence available against the insured, such as alleging contributory negligence, or volenti fit non injuria, or that the action has become time barred. But the wrongdoer cannot plead that the damages should be reduced because of the insured’s entitlement to claim against an insurer. See C Mitchell, “Defences to an Insurer’s Subrogated Action” [1996] LMCLQ 343. [1221] Bradburn v The Great Western Railway Company (1874) 10 LR Exch 1 [The plaintiff, who had been injured in a train accident, received £31 under an accident policy and was then awarded £217 from the railway. The railway

argued that the award should be reduced by the amount of the policy payment.] Piggot B: ‘The plaintiff is entitled to recover the damages caused to him by the negligence of the defendants, and there is no reason or justice in setting off what the plaintiff has entitled himself to under a contract with third persons, by which he has bargained for the payment of a sum of money in the event of an accident happening to him. He does not receive that sum of money because of the accident, but because he has made a contract providing for the contingency; an accident must occur to entitle him to it, but it is not the accident, but his contract, which is the cause of his receiving it.’

The parties can agree in their contract to amend the usual rights of subrogation, and, in particular, the insurer can waive these rights: see National Oilwell (UK) Ltd v Davy Offshore Ltd [1993] 2 Lloyd’s Rep 582 [see 1212]

12.7 Is Subrogation Justified? Subrogation is sometimes justified as a means of both reducing losses, and, therefore, premiums, and deterring wrongdoing by fixing liability on the wrongdoer. One difficulty with these arguments is that insurers are unlikely to use rights of subrogation unless they are able to enforce any judgment award, and this means that such rights are likely to be exercised only where the wrongdoer is insured. If that

is the case, then subrogation becomes merely a way of shifting losses from one insurer to another and does not fix liability on the wrongdoer. This also means those insurers who recoup their losses today will be paying out tomorrow to cover the liabilities of wrongdoers whom they insure, and that would, presumably, nullify any reduction in premiums that might be attributable to subrogation. It is also curious that, while subrogation is meant to prevent an insured from profiting, the same principle is not applied to insurers who, if they do recoup any money paid to the insured, have lost nothing and have gained the premiums. [1222] J Derham, Subrogation in Insurance Law (Sydney, The Law Book Company, 1985) [footnotes omitted] ‘The justifications put forward for the retention of subrogation are both philosophic and economic. The economic argument is that subrogation results in lower premiums…However this view has been treated with scepticism in other quarters. For example Swann J commented in the District Court of Appeal in Florida in De Cespedes v Prudence Mutual Casualty Co of Chicago, Illinois [(1966) 193 So 2d 224 at 227–28] that subrogation “has frequently become a source of windfall to insurers in that the anticipated recoveries under subrogation rights are generally not reflected in the computation of premium rates”. Nevertheless, even if one accepts that subrogation does lower rate structures, this will be of little benefit if the reduction is outweighed by the costs that subrogation imposes on the community. Subrogation litigation occupies

a considerable amount of the time of the courts. It is also clear that it must result in an increase in liability insurance premiums. Therefore, in order to offset these economic liabilities, subrogation should not only bring about a reduction in premiums, but it should result in a reasonably substantial reduction. However there is evidence suggesting that subrogation recoveries in some classes of insurance are minimal compared to the amounts paid out by insurers. In the United States James Meyer [“Subrogation Rights and Recoveries Arising out of First Party Contracts” (1973) 9 The Forum 83] made an estimate of the percentage that subrogation recoveries bore to total insurance payments made by insurers in that country in 1972. These percentages were, in a class by class analysis, 14.15 per cent in ocean marine insurance, 8.56 per cent in motor vehicle property insurance, 2.45 per cent in workers’ compensation insurance, 0.80 per cent in homeowners’ insurance, and 0.68 per cent in fire insurance. The average percentage recovery was 2.96 per cent. Similar results were obtained by Dr Horn [Subrogation in Insurance Theory and Practice (1964)] for the calendar year 1960. Though no figures have been given for ocean marine insurance, sorne of his other results were 12.5 per cent in automobile collision insurance, 1.4 per cent in workers’ compensation insurance, 0.5 per cent in homeowners’ insurance, and 0.6 per cent in fire insurance. A comparison of both sets of statistics indicates that it was really only with respect to ocean marine and motor vehicle property insurance that subrogation recoveries constituted a sizeable percentage of total insurance payments. Presumably then it would only have been in the case of these two classes of insurance that it could be said that subrogation recoveries would have had more than a marginal effect on rate structures. In a submission to the Australian Law ReformCommission [Report on Insurance Contracts], NRMA Insurance said that, on the basis of its subrogation recovery figures for 1978, the

premium otherwise payable by each of its motor vehicle property damage policy holders was reduced by approximately $6. However this ignores the costs that subrogation litigation imposes on the community generally. Moreover, as the above percentage — subrogation recovery statistics indicate, it would be dangerous to extrapolate this conclusion to other forms of insurance. One possible philosophic objection to the abolition of subrogation rights in insurance is that the question of whether the third party should be saddled with liability would then depend on the fortuitous circumstance of whether the person suffering loss was insured. However this notion is not foreign to tort law. For example the extent of the damages payable by a tortfeasor in a personal injuries action varies according to the susceptibility of the plaintiff to injury. The question of whether a person suffering loss has indemnity insurance would be no more than a variation of this “egg shell skull” principle. Perhaps a more important philosophic objection is that the prospect of civil liability may specifically deter some people from engaging in conduct likely to cause a loss.” While it is probably correct to say that the prospect of civil liability may act as a deterrent to intentional, as well as reckless, conduct, its possible effect upon mere negligence is more uncertain. On the other hand, Harper and James [The Law of Torts (1956)] have doubted the deterrent effect of an award of damages. They have argued that the fear of civil liability is not the only factor inducing care. Other factors are important, as for example the danger that the third party may injure himself, or that he may commit a crime, or that he may incur bad public or labour relations. Further, many accidents are not the result of a conscious decision by the tortfeasor. His own lack of skill and experience, or mental attitude, may cause him to be accident prone. Nevertheless there is a competing view. Proponents of this view concede that the fear of tort liability is not going to deter someone from performing a

specific negligent act which is likely to cause accidents, because obviously if the accident is the result of negligence the immediate act causing it is not the result of conscious risk taking. Rather they argue that the fear of tort liability may act as a deterrent at an earlier point in time, in that it may deter people from causing accidents by bringing pressure to bear before they actually get into an accident causing situation. However, as Atiyah [Accidents, Compensation and the Law (3rd edn, 1980)] has pointed out, this is subject to the limitation that the fear of tort liability could only be effective as a deterrent to the extent that people do indeed recognise accident-causing factors or situations. This is by no means always the case, and it may be questioned whether any benefits that may indeed accrue from retaining the insurer’s right to bring a subrogation action in negligence cases are not outweighed by the costs that the exercise of the right imposes on the community. A view commonly expressed is that the modern prevalence of liability insurance has reduced the deterrent effect of a damages award (at least in relation to losses not deliberately caused). However this takes no account of the effect that a possible increase in liability insurance premiums may have as a specific deterrent in inducing care in the insured. Whether indeed, and to what extent, this may be the case is a matter for speculation. For example a survey conducted by the Department of Transport in the United States indicated that only 21 per cent of motorists thought that their insurance premiums would be increased if they were involved in an accident (Linden, Canadian Tort Law (3rd edn, 1982)]. Motorists in Australia and in England may have a greater awareness of the possibility of losing a no-claims bonus, though Atiyah has agreed with the opinion expressed by one insurer that the fear of loss of a no-claims bonus is unlikely to play a significant role in making drivers drive more carefully. If the insured is a large enterprise dealing exclusively with one insurer, the competitive nature

of the insurance industry may mean that the insurer may be prepared to forgo any justified increase in liability insurance premiums in order to ensure that it retains the insured’s other insurance business (particularly the fire account), or at least to offer a quantity discount that will “swallow up” any increase that there otherwise may have been in liability insurance premiums. Moreover, even if there is an increase, the insured may be in a position to pass this on to its customers through a marginal increase in the price of his product. Unfortunately there appears to be little detailed information available on the rating methods employed by insurance companies. However, at least in the case of employer’s liability insurance, it seems that most businesses are considered to be too small for their own previous loss experience to form a reliable guide to future loss experience. Premiums to a large extent are based upon the experience of the class of industry of which the insured is a member. It is not clear if, and to what extent, this or a similar practice is also applied in relation to other forms of liability insurance. Nevertheless one consequence of this form of rating method is that, while it may be reconciled with the theory of general deterrence, it is unlikely to give rise to a significant degree of specific deterrence inducing care on an individual basis in each insured. The preceding discussion concerned specific deterrence, which emphasises the effect of liability on the conduct of a particular person. The possibility of liability is said to act as a direct deterrent to the performance of specific conduct likely to cause losses. This should be compared to the economic theory of general deterrence, or resource allocation, favoured by Professor Calabresi [The Cost of Accidents (1970)]. The theory is complex, and it has spawned a considerable amount of literature in recent years. In essence it means that the costs of accidents should be placed on those acts or activities (or combination of them) which could avoid accident costs the most cheaply.

It is based upon the free market principle. If the costs of accidents resulting from a particular activity are charged to it, the activity will have a higher price to the extent of the accident costs. This may lead to a drop in demand, and a resulting decrease in accidents. If those responsible for marketing the activity want to increase demand, they will have to take steps to reduce its price by reducing accident costs. The result then will be that total accident costs will have been reduced by the operation of market forces. General deterrence does not seek to diminish accident costs by directly attacking specific occasions of danger. Instead it seeks to reduce them by making more expensive those activities which are more likely to cause accidents and thereby making more attractive their safer substitutes. The imposition of liability is based upon the ability to evaluate the risk of accidents and to take steps to avoid their occurrence, rather than upon fault. In some cases these may overlap, but this will not always be the case. To the extent that tort law does conform with the purposes of general deterrence, it may be argued that subrogation actions should be encouraged as a means of inducing market forces to lower the incidence of accidents and their costs. However the theory of general deterrence is not without its critics. An important assumption is that the shifting of the burden of losses resulting from a particular accident causing activity will result in a drop in demand for that activity. Presumably this would only occur if the increase in price attributable to accident costs is significant in comparison to the price otherwise chargeable for the activity without accident costs. However, as Atiyah has noted, the price of this or a competing activity may be distorted by government taxes or subsidies to the extent that the relative costs attributable to the activity for accidents become insignificant. Moreover consumer preference for the particular activity may be so strong that consumers may not be deterred by the higher price, in

which case market forces will not induce those responsible for it to take accident prevention steps. In either case, the use of the courts as a means of shifting the loss will have imposed an overall expense on the community without a corresponding benefit being obtained in return in the form of a reduction in accidents and their costs. It is also assumed that the aim and purpose of each individual is to pursue his own profit, so that those responsible for an accident causing activity will only take accident prevention steps if threatened with a loss of profit. It is debatable whether this would apply to public enterprises, and similarly some businessmen may be guided by a sense of public duty in trying to reduce accidents. Thus Atiyah doubts that accident costs can always, or indeed often, be best minimised by the use of market forces. Nevertheless this theory of general deterrence has certain attractions, and to the extent that tort law may reflect its purpose it may be that the benefits to be obtained from the use of market forces as a means of reducing accidents and their costs may outweigh the costs imposed on the community by subrogation litigation. There is a strong argument in favour of the view that the burden of a loss should remain with the insurer of the party suffering the loss. The insurer is in the position of being able to spread the loss through the premium paying public, while a similar mechanism often is not available to a third party without liability insurance. A major function of any compensation system is often said to be loss spreading. The system should ensure that the burden of a loss is distributed amongst a large class of persons rather than being borne by a single individual. On this view, the insurer of the party suffering loss should accept ultimate responsibility rather than an uninsured third party who in many cases will be a poor loss distributor. Indeed loss spreading was one of the factors considered by the Californian Court of Appeal in Patent Scaffolding Co v William Simpson Construction Co

[(1967) 64 Cal Rptr 187 at 194] when it refused to allow an insurer to shift the burden of the loss on to the defendant in this subrogation action. The contest is not between two insurance companies, each of which has received premiums for bearing the loss which ultimately occurred, but between insurers and a general contractor who received no independent consideration for the assumption of the risk. The insurers, being in the insurance business, are in a position effectively to spread the risk and to gauge their premiums upon their loss experience. Upon the evidence in the record we are unable to say that Simpson occupies a similar position. Of course the third party may possess liability insurance, in which case the effect of subrogation is to shift the loss from one good loss distributor (the subrogated insurer) on to another good loss distributor (the liability insurer). Since the shifting of the loss will involve an overall increase in administrative and legal expenses, as well as imposing upon the community the costs of providing legal machinery for hearing the dispute, it would be sensible to leave the loss with the first insurer. This approach was not adopted in section 65 of the Insurance Contracts Act 1984 (Cth). Section 65 limits the insurer’s right to prosecute a subrogation action against a person in a family or other personal relationship with the insured, or against a person using a motor vehicle with the insured’s consent when that vehicle is the subject matter of the insurance. However this limitation is expressed to apply only when the third party is uninsured. If he is insured a subrogation action may still be brought against him (or, in reality, against his liability insurer), and judgment may be obtained to the extent of his insurance coverage. The desirability of specifically preserving this “cumbersome and uneconomic shifting of dollars from one insurance company to another through the means of subrogation” [Cirelli v The Ohio Casualty Insurance Co (1975) 337 A2d 405 at 409, per Larner AJSC] is not

readily apparent. A further example arises when a subrogated workers’ compensation insurer sues a third party motor vehicle insurer in respect of injuries sustained by an employee while travelling to or from work. The shifting of the loss is difficult to rationalise on the basis of deterrence, since in Australia premiums for compulsory third party insurance are standardised. This does seem to constitute a particularly wasteful source of litigation. The Australian Law Reform Commission, in rejecting a call for the abolition of subrogation rights in all cases in which the conduct of the third party was not intentional or reckless, expressed concern as to the effect that this would have on reinsurance. It noted that the Australian insurance market is small by international standards, and suggested that international reinsurers might be unwilling to devise special rate structures for the Australian market in isolation. Certainly this is a valid consideration. It indicates that any initiative regarding the abolition of subrogation rights in the context of insurance possibly may have to originate in countries such as England or the United States which have large insurance markets.’

[1223] R Hasson, “Subrogation in Insurance Law: A Critical Evaluation” (1985) 5 OJLS 416 [footnotes omitted] ‘(a) Subrogation and overlapping coverage The main function of the subrogation doctrine is that it requires overlapping insurance coverage. Thus, in a sale both the vendor and the purchaser will have to insure the same piece of property, unless the purchaser wishes to pay a substantial sum of money for “a charred ruin”. Again, in the mortgagee-mortgagor relationship, it will be prudent for the mortgagor to protect his/her interest by taking out insurance. In both these cases, two policies are

being taken out to cover one risk. This is the real attraction of subrogation for insurers. The situation becomes even more promising for insurers if we consider the situation of a landlord and a commercial tenant. In this case, both the landlord and tenant will carry insurance on the same building. In addition, the tenant’s employees would be well advised to carry liability insurance. Similarly, people who supply the tenant with goods would be well advised to take out liability insurance, as would people who come to effect repairs. Thus, in this situation five groups of people may well be paying insurance premiums in respect of one risk. If the insurance companies’ interest lies in being able to recover several premiums in respect of one risk, it might be asked why they bother to sue at all. One answer must be that, the occasional action is necessary to make sure that all potential tortfeasors and potential contract-breakers maintain their liability insurance. If insurers did not bring any subrogated claims, then some potential tortfeasors might cease to procure overlapping coverage. Another answer must be that individual insurers see their interest as being different from the aggregate interest and pursue their individual interest by bringing subrogated claims.

(b) Subrogation and wasteful litigation Three examples of wasteful subrogated cases appeared in English courts recently. In Harbutt’s Plasticine Ltd v Wayne Tank and Pump Co Ltd [[1970] 1 QB 447 (CA)] the defendants agreed with the plaintiffs to design and install equipment for storing stearine in a molten state. For this purpose, the defendants specified durapipe which was wholly unsuitable because it was liable to distort at temperatures above 187°F. A fire was caused when the durapipe distorted under heat causing molten stearine to escape and ignite. Despite the presence of a

broad exemption clause, the Court of Appeal, in a decision that attracted a great deal of criticism, held that the defendant had been guilty of a fundamental breach and was liable to pay £172,966. Despite the fact that it had drafted a very wide exemption clause, the defendant had taken out liability insurance. In a second action, arising out of this saga, the defendant sued one of its insurers in a case which was heard by the Court of Appeal. No one knows the cost of shifting the loss of £172,966 from one insurer to another but one can be certain that the cost was very high. It is in this connection that Professor Atiyah has pertinently asked ‘would the decision [in Harbutt’s Plasticine] have been much more sensible in policy even if there had been no exclusion at all?” Next, in Home Office v Dorset Yacht [[1970] AC 1004], seven Borstal boys escaped from the supervision of three officers and damaged the plaintiff’s yacht. The cost of the damage to the yacht was £1315 13s. 8d. The insurer having made good the damage, now brought a subrogated claim against the Crown. In this case, it is clear that the cost of shifting the loss from the insurer to the Crown vastly exceeded the small amount of money paid out by the insurer. One might seek to justify this fiasco by arguing that their Lordships reviewed fully the system of supervision of borstal boys but as Lord Dilhorne pointed out several times in his dissent, the courts are not a suitable institution for determining rules for compensating property claims and, at the same time, trying to determine good penal policy. A third case which shows the costs of trying to shift an insured loss from one insurer to another is Photo Production Ltd v Securicor Transport Ltd [[1980] AC 827]. In that case it will be remembered that Musgrove, the patrolman employed by Securicor caused a loss by starting a small fire which got out of control and destroyed the insured factory belonging to Photo Production. Photo Production’s insurers failed in

their subrogated provided:

claim

because

the

exclusion

clause

“under no circumstances shall the company be responsible for any injurious act or default by any employee of the company unless such act or default could have been foreseen and avoided by the exercise of due diligence on the part of the company and his employer.” Although the attempt by Photo Production’s insurers to shift the loss to Securicor’s insurers failed, the cost of attempting to shift the loss was enormous. It is important to note that slightly different facts in Photo Production might have produced a different result. Thus, suppose that: (i) the employee who caused the fire had been dismissed for recklessness from his previous employment ten years ago or; (2) that the employee who set the fire had been sent by Securicor despite Securicor’s knowledge that this employee had been under great emotional strain because his wife and children had been killed a week earlier. In either (or both) of these cases, Securicor might well be held to have acted without “due diligence”. In this case, Photo Production’s insurers would have been able to shift the loss to Securicor’s insurers. Moreover, Securior might have had to sue its insurers as did Wayne Tank in order to be indemnified. However beneficial all this activity might be to insurance companies, lawyers, textbook and note writers, it can be seen as an activity that is scandalously wasteful. It is difficult to believe that this kind of waste would be tolerated in the public sector.

(c) Subrogation as the destroyer of the utility of insurance contracts Although the most serious charges against the doctrine of subrogation are that it promotes overlapping coverage and

wasteful litigation, the doctrine can also render worthless (or, at least, substantially undermine) the value of an insurance contract. For example, in an employer’s liability insurance situation, subrogation may substantially destroy the utility of the insurance contract both from the employer’s point of view and that of its employees. In the first place, if the insurer brings a subrogated claim, the employer may well be faced with a strike, which will end only after it has compensated the employee against whom a subrogated claim has been brought. Even if no strike occurs, the employer may well feel that it should compensate a valued employee it does not want to lose. Here, the utility of employers’ liability insurance is undermined by the doctrine of subrogation.’

[1224] RM Baron, “Subrogation: A Pandora’s Box Awaiting Closure” (1996) 41 South Dakota L Rev 237 [footnotes omitted] ‘As a matter of fundamental justice, the “make whole” doctrine seems to be the most appealing. The insured should be fully compensated for his or her loss before requiring reimbursement to the first party insurer. After all, the insured (or someone on his or her behalf) paid a premium to that insurer for the purpose of obtaining security and peace of mind in the event a loss should occur. A realistic approach to this issue also requires the court look at the net recovery received by the insured. If the insured has to pay one-third of the recovery to an attorney in order to obtain a recovery, then the court should not be blind to that reality. This would seem to be especially true where the court is faced with the choice of either truly making the insured whole or allowing the subrogated insurer to collect on a claim for which it received a premium, thereby allowing

that windfall collection to go to the profit coffer of the insurer. There are other ameliorating doctrines. The insurer can either agree, or be required, to give up part of the subrogated claim. This may occur on a straight pro rata basis with the insured. It can also occur under the “common fund” theory whereby the insurer is required to pay its share of the attorney’s fees and costs incurred in the creation and preservation of the settlement fund which benefits both the insured and the subrogated insurer. These latter two devices are, however, minimally effective in dealing with the overall harshness seen in subrogation. None the less, they have some effect and should be promoted by the courts where the “make whole” doctrine is not utilised. These ameliorating doctrines are also available in matters of property insurance, although the issues are typically less critical in the property insurance context. In the end, the decision must be made as to whether the insurer’s interest in securing a subrogated recovery should prevail over the insured’s interest in being compensated for a loss. In the resolution of this question, there can be no dispute with the fact that, in the vast majority of cases, the allowance of subrogation truly defeats the opportunity for the insured to be fully and justly compensated. Consequently, the best way to close the Pandora’s Box that has plagued the insurance industry is to deny subrogation altogether for personal injury claims.’

Note: See also, RM Baron, “Subrogation in Medical Expense Claims: The ‘Double Recovery’ Myth and the Feasibility of Anti-Subrogation Laws” (1992) 96 Dick L Rev 581; RC Horn, Subrogation in Insurance Theory and Practice (Homewood, Illinois, University of

Pennsylvania, 1964); ML Marasinghe, “An Historical Introduction to the Doctrine of Subrogation” [1975] 10 Valparaiso U L Rev 45, 275; GR Veal, “Subrogation: The Duties and Obligations of the Insured and Rights of the Insurer Revisited” (1992) 28 Tort and Ins LJ 69.

12.8 Abandonment Following payment for a total loss, the insurer is entitled — but not bound — to take over the whole of the interest that the insured has in the subject matter of the insurance. Like subrogation, this right derives from the principle of indemnity. But, while subrogation only entitles the insurer to recoup the payment to the insured, abandonment entitles the insurer ‘to every benefit to which the assured is entitled in respect of the thing to which the contract of insurance relates, but to nothing more’ (The Sea Insurance Co v Hadden & Wainwright (1884) 13 QB 706, Lindley LJ). [1225] Marine Insurance Act 1906 ‘section 63 (1) Where there is a valid abandonment the insurer is entitled to take over the interest of the assured in whatever may remain of the subject-matter insured, and all proprietary rights incidental thereto. (2) Upon the abandonment of a ship, the insurer thereof is entitled to any freight in course of being earned, and which is earned by her subsequent to the casualty causing the loss, less the expenses of earning it incurred

after the casualty; and, where the ship is carrying the owner’s goods, the insurer is entitled to a reasonable remuneration for the carriage of them subsequent to the casualty causing the loss.’

[1226] Simpson & Co v Thomson, Burrell (1877) 3 App Cas 279 (HL) [see [1211]] Lord Blackburn: ‘My Lords, I do not doubt at all that where the owners of an insured ship have claimed or been paid as for a total loss, the property in what remains of the ship, and all rights incident to the property, are transferred to the underwriters as from the time of the disaster in respect of which the total loss is claimed for and paid. The right to receive payment of freight accruing due but not earned at the time of the disaster is one of those rights so incident to the property in the ship, and it therefore passes to the underwriters because the ship has become their property, just as it would have passed to a mortgagee of the ship who before the freight was completely earned had taken possession of the ship: see Keith v Burrows (2 App Cas 636). This is at times very hard upon the insured owner of the ship; he can, however, avoid it by claiming only for a partial loss, keeping the property in himself, and so keeping the right to earn the accruing freight. In such a case he recovers an indemnity for the amount of the loss actually sustained, in calculating which all the benefits incident to the property retained by the shipowner must be considered. But the right of the assured to recover damages from a third person is not one of those rights which are incident to the property in the ship; it does pass to the underwriters in case of payment for a total loss, but on a different principle. And on this same

principle it does pass to the underwriters who have satisfied a claim for a partial loss, though no property in the ship passes.’

12.9 Double Insurance and Contribution There is nothing to prevent an insured from effecting multiple policies on the same risk. Indeed, it is not uncommon for the same property to be insured under different policies: a camera taken by its owner on a motoring holiday might be covered under policies on household contents, motor insurance and travel. However, the principle of indemnity means that an insured cannot recover more than the loss suffered. This does not prevent different persons with an insurable interest from insuring the same property and each recovering the amount of their loss (Union Marine Insurance Co Ltd v Martin (1866) 35 LJCP 181; Lonsdale & Thompson Ltd v Black Arrow Group Plc [1993] Ch 361). Nor does it prevent claims under multiple life policies since they are not based on the principle of indemnity. Where there has been double insurance the insurer who has paid out for the loss has an equitable right to a contribution from the other insurer. This right should be distinguished from subrogation, which is the right of an insurer to proceed against third parties responsible for the loss. Where there is double insurance, on the other hand, the insurer who has paid can bring an action in their name against the other insurer.

[1227] Godin v London Assurance Co (1758) 1 Burr 489 Lord Mansfield CJ: ‘Where a man makes a double insurance of the same thing, in such a manner that he can clearly recover, against several insurers in distinct policies, a double satisfaction… the law certainly says that he ought not to recover doubly for the same loss, but be content with one single satisfaction for it. And if the whole should be recovered from one (that is, one insurer), he ought to stand in the place of the insured, to receive contribution from the other, who was equally liable to pay the whole.’

[1228] Sickness and Accident Assurance Association Ltd v General Accident Assurance Corporation Ltd (1892) 19 R 977 (Court of Session) Lord Low: [His lordship contrasted subrogation and double insurance by referring to a leading subrogation case, Simpson & Co v Thomson, Birrell (1877) 3 App Cas 279 (HL), 12.11, 12.26]. ‘That case, however, appears to me to belong to a totally different branch of law from the present case. It exemplified an application of the doctrine that where the insured has a primary right against third parties who have been the authors of the loss, the insurers on making good the loss are entitled to be put in his place, and to enforce the remedies which he would have had against these third parties. That, however, is not the doctrine which lies at the root of the rule of marine insurance to which I have referred, but it is a doctrine which would be destructive of that rule. The right of an underwriter who has indemnified the insured to claim contribution from the other underwriters cannot be founded

upon the doctrine of subrogation, because an assignee can have no higher right than his cedent, and a shipowner who has received full indemnity from one underwriter can never make any claim against another underwriter.’

[1229] Legal and General Assurance Society Ltd v Drake Insurance Co [1992] QB 887 (CA) Ralph Gibson LJ: ‘The concept [of contribution] seems to have developed out of cases of co-sureties in which all are liable to the creditor. If one surety is required to pay the creditor, then the others, all being equally liable to pay, receive the benefit of that payment. The co-sureties might be joint — each aware of the promises made by the others — but it made no difference if the promises made by the sureties were several and in different instruments and made in ignorance of the promises made by the others.’

[1230] Marine Insurance Act 1906 ‘section 32 (1) 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. (2) Where the assured is over-insured by double insurance— (a) The assured, unless the policy otherwise provides, may claim payment from the insurers in such order as he may think fit, provided that he is not entitled to receive any sum in excess of the indemnity allowed by this Act;

(b) Where the policy under which the assured claims is a valued policy, the assured must give credit as against the valuation for any sum received by him under any other policy without regard to the actual value of the subject-matter insured; (c) Where the policy under which the assured claims is an unvalued policy he must give credit, as against the full insurable value, for any sum received by him under any other policy: (d) Where the assured receives any sum in excess of the indemnity allowed by this Act, he is deemed to hold such sum in trust for the insurers, according to their right of contribution among themselves.’ ‘section 80 (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.’

[1231] North British & Mercantile Insurance Co v London, Liverpool & Globe Insurance Co (1875) 5 Ch D 569 (CA) Mellish LJ: ‘…I think if the same person in respect of the same right insures in two offices, there is no reason why they should not contribute in equal proportions in respect of a fire policy as they would in the case of a marine policy. The rule is perfectly established in the case of a marine policy that

contribution only applies where it is an insurance by the same person having the same rights, and does not apply where different person insure in respect of different rights. The reason of that is obvious enough. Where different persons insure the same property in respect of their different rights they may be divided into two classes. It may be that the interest of the two between them makes up the whole property, as in the case of a tenant for life and remainderman. Then if each insures, although they may use words apparently insuring the whole property, yet they would recover from their respective insurance companies the value of their own interests, and of course those values added together would make up the value of the whole property. Therefore it would not be a case either of subrogation or contribution, because the loss would be divided between the two companies in proportion to the interests which the respective persons assured had in the property. But then there may be cases where, although two different persons insured in respect of different rights, each of them can recover the whole, as in the case of a mortgagor and mortgagee. But wherever that is the case it will necessarily follow that one of these two has a remedy over against the other, because the same property cannot in value belong at the same time to two different persons. Each of them may have an interest which entitles him to insure for the full value, because in certain events, for instance, if the other person becomes insolvent, it may be he would lose the full value of the property, and therefore would have in law an insurable interest; but yet it must be that if each recover the full value of the property from their respective offices with whom they insure, one office must have a remedy against the other. I think whenever that is the case the company which has insured the person who has the remedy over succeeds to his right of remedy over, and then it is a case of subrogation.’

[1232] Austin v Zurich General Accident and Liability Insurance Co Ltd [1945] KB 250 CA [Zurich issued a motor policy to Aldridge which extended cover to anyone driving with his permission. Austin, who had his own motor policy with Bell, drove Aldridge’s car with the latter’s permission. There was an accident and claims against Austin were settled by Bell. An action was then brought in Austin’s name on behalf of Bell against Zurich.] Mackinnon LJ: ‘This apparently was treated below as a claim by the Bell association against the Zurich company, put forward by virtue of their right of subrogation. If it was a claim in subrogation, it would be rightly pursued in the name of Austin; but, as it seems to me, in truth the claim of the Bell association was one of contribution against the Zurich company on the principle of double insurance, and such a claim ought to be brought in the name of the underwriters against the defendant company and could not be pursued in the name of the assured under the guise of a claim by way of subrogation.’

[1233] Eagle Star Insurance Co Ltd v Provincial Insurance plc [1994] 1 AC 130 (PC) [Mr O’Reilly was insured under a motor policy by Eagle Star against liability to third parties. The Road Traffic Act rendered of no effect any policy condition that terminated liability in the event of some specified thing being done or not done after the

accident. O’Reilly, having taken his own car to be repaired, was lent a car by the repairers, who had a motor policy with Provincial that covered any authorised driver. Both policies contained conditions that the insurer was not liable to contribute more than its rateable proportion of any loss and was not liable if the insured was entitled to an indemnity under another policy. Through his negligent driving, O’Reilly injured Simms. The accident was not reported to Provincial, which entitled it to repudiate liability to the insured, although a provision in the Road Traffic Act prevented repudiation of liability to Simms. Simms was awarded damages against O’Reilly. He did not receive payment and, therefore, he sued both insurers under the rights given under the Act to third parties to sue insurers directly in motor cases.] Lord Woolf: ‘The distinguishing feature of the present case, to which these principles have not previously been directly applied, was that in this case it was not the insured who was seeking an indemnity but a third party with whom neither insurance company had any contractual relationship. Instead of the liability arising under contract, it arose under statute. However, this distinction in the source of the liability does not by itself justify any departure from the normal approach. If the position of the two insurers was otherwise identical, that is to say, they were both equally under a contractual obligation to indemnify Mr O’Reilly or were both equally under no such contractual liability, then it would be fair, and this was accepted by both insurers, that…the insurers, as between themselves, would have to share equally the liability to Mr Simms.

…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 these 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. If the contractual approach is adopted, then there can be no justification for departing from the contractual position by creating for the purposes of contribution between the coinsurers a special cut-off point which requires the position to be judged at the date of the loss. Having such a cut-off point could produce results which do not reflect the contractual situation so far as liability to the insured is concerned. Looking at the issue from the insurer’s and insured’s standpoint, it makes no difference if an insurer defeats a claim by relying on action taken before or after the loss has occurred. If both insurers would be under no liability to the person who would be insured, then they should share the statutory liability for loss equally irrespective of the date upon which they repudiated liability. If both insurers are liable at least in part to the person insured, then they should contribute to their statutory liability in accordance with their respective liability to the person insured for the loss. While this could have the result that the action of a person insured in relation to one insurer can affect the rights of contribution of the other insurer, this is an inevitable consequence of one insurer being able to take advantage of any limitation of his contractual liabilities on the question of contribution.

However before suggesting this could be unfair it has to be remembered that it is unlikely that the existence of the other insurer would have been known at the time that the contract of insurance was made. …The only case which had a direct bearing on the issue now being considered is the decision of Judge Rogers in the Mayor’s and City of London Court in Monksfield v Vehicle and General Insurance Co Ltd [1971] 1 Lloyd’s Rep 139. That case was disapproved of by the majority in the Court of Appeal because it did not accord with their conclusion that the date of the loss was the cut-off point at which contribution had to be decided. However, far from that decision being wrong, it is correctly decided and properly regarded in Halsbury’s Laws of England, 4th edn, vol 25 (1978), p 286, para 539, as being support for the third of the conditions which Halsbury accurately states must be satisfied before a right of contribution can arise. That condition is: “Each policy must be in force at the time of the loss. There is no contribution if one of the policies has already become void or the risk under it has not yet attached; the insurer from whom contribution is claimed can repudiate liability under his policy on the ground that the assured has broken a condition.” In this case therefore both insurers are in the same position. They were both under a statutory liability in relation to the claim of the third party but they both would have been entitled to repudiate liability to the insured person. No distinction should be made in relation to their respective positions and accordingly they should each contribute equally to the amount payable to Mr Simms.’

Notes:

1. In North British & Mercontik Co v London, Liverpcol & Globe Insurance Co (1877) 5 ChD 569 grain was stored by wharfingers and insured both by them and by the owner of the grain. This was, therefore, not double insurance and the insurer who paid one of these parties for loss of the grain could not claim a contribution from the insurer of the other. Of course, if the loss was caused by the negligence of the wharfinger, the insurer who paid the grain’s owner could use their right of subrogation to sue the wharfinger and this would probably mean the loss falling on the latter’s insurers. 2. An insurer wishing to recover a contribution from another insurer must establish: ‘(a) that he was liable under his own policy; (b) that he has paid under his policy; (c) that the defendants were liable under their policy; and (d) that the defendants have not paid under their policy.’ (Boag v Economic Insurance Co [1954] 2 Lloyd’s Rep 581, per McNair J) 3. The Privy Council Eagle Star declined to follow Legal and General Assurance Society Ltd v Drake [1992] QB 887, in which the Court of Appeal held that the liability to contribute was determined at the time of the loss and, therefore, that liability was not affected by the breach of a policy term requiring the insured to notify the insurer of the loss within 14 days. Recently, Richard Siberry QC (sitting as a deputy High Court judge) in O’Kane v Jones

[2003] All ER (D) 510 has chosen to follow the Legal and General decision on this issue. He held that post-contractual cancellation of a policy does not affect the obligation of the insurer to contribute. The Court of Appeal in Legal and General also concluded that a rateable proportion clause, which rendered the insurer liable for only 50% of the loss where there was double insurance, prevented the insurer, who paid the full loss, from seeking a contribution because the overpayment was treated as a voluntary payment. 4. The rule on double insurance has also been adopted in other common law jurisdictions: see, for instance, Albion Insurance Company Limited v Government Insurance Office of New South Wales (1970) 121 CLR 342 (High Court of Australia). In a New Zealand case the owner of land contracted with a builder to construct a building. It was agreed that the builder would take out insurance to cover the project. However, the owner of the land decided also to take out insurance. Following payment on the builder’s policy, the landowner’s insurers were held not liable to contribute because it was the intention of the builder and the landowner that the loss should fall on the builder’s insurers (Commercial Union v Murphy ([1989] 1 NZLR 687, Court of Appeal)). 5. There are several methods for calculating the contribution each insurer must make. The first is the independent liability method, which

involves the contribution of each insurer being adjusted in proportion to the amount each would be liable to pay the insured independently: if insurer A has insured the property for £1 million and insurer B has insured it for £2 million, then B would contribute in a ratio of 2:1. Second is the maximum liability method. Here contributions are in proportion to each insurer’s maximum liability: if the insurer A’s maximum liability is £100,000 and insurer B’s is £10,000, then A will contribute in a ratio of 10:1. Finally, the common liability method involves both insurers bearing the loss equally up to the amount for which each would have been liable independently. This means that in the last example, A and B would bear equal liability up to £10,000 and then A would bear sole liability above that figure. The method that applies in any situation depends on the contract. However, in O’Kane v Jones [2003] All ER(D) 510 it was held that section 80 of the Marine Insurance Act 1906 (see [1230]) excludes the common liability method. The section states that each insurer is bound ‘to contribute rateably to the loss in proportion to the amount for which he is liable under his contract’, and the common liability method would lead to the contributions not being in proportion to the amounts for which the insurers were liable.

12.9.1 Rateable Proportion Clauses Policies commonly include a rateable proportion clause. The principal effect of this is to prevent an insured, who has double insurance, from claiming the full loss under the policy. The clause makes the insurer liable only for their rateable proportion and requires the insured (rather than the insurer) to pursue the other parts of the claim from the other insurers. Such clauses are typically justified as a way of preventing fraud, but they can place a burden on the honest insured who, having paid a premium for full cover, might reasonably expect the insurer to do the work of obtaining contributions. Moreover, since many people innocently take out double insurance this could be a serious problem if insurers routinely insisted on the terms of their policies and the fact that they seem not to do so hardly meets the point. [1234] Weddell v Road Transport and General Insurance Co Ltd [1932] 2 KB 563 [A motor policy contained the following clauses: ‘The company will at the request of the insured treat as though he were the insured any relative or friend of the insured whilst driving such motor-car for social, domestic or pleasure purposes with the insured’s general knowledge and consent, provided (a) that such relative or friend is not entitled to indemnity under any other policy.’ (section II) ‘If at the time any claim arises under this policy there is any other existing insurance covering the same loss, damage or liability the company shall not be liable…to pay

or contribute more than its rateable proportion of any loss, damage, compensation, costs or expense. Provided always that nothing in this condition shall impose on the company any liability from which but for this condition it would have been relieved under the provisions of section II of this policy.’ (condition 4)

The insured’s brother, who was driving the car at the time of the accident, also had a motor policy that covered him for driving a car not owned by him ‘if no indemnity is afforded the insured by any other insurance.’ It was held that both insurers were liable to contribute half of the claim.] Rowlatt J: ‘It is to be borne in mind that the risk covered by the clause as to a relative or friend is an extension of the scope of the policy. It gives protection to a person other than the assured. So, too, the clause in the Cornhill company’s policy covering the assured when driving a car not belonging to him is an extension of the primary purpose of the policy, which is to cover risks to and in connection with a particular car or cars of the assured mentioned in the schedule. The general purpose of the proviso [in section II] seems to be to make such extensions operate only as secondary cover, available only in the absence of other insurance regarded as primary, not including, one would suppose, other insurance also of a secondary character. In my judgment it is unreasonable to suppose that it was intended that clauses such as these should cancel each other (by neglecting in each case the proviso in the other policy) with the result that, on the ground in each case that the loss is covered elsewhere, it is covered nowhere. On the contrary the reasonable construction is to exclude from the category of co-existing cover any cover which is expressed to be itself

cancelled by such co-existence, and to hold in such cases that both companies are liable, subject of course in both cases to any rateable proportion clause which there may be. In other words, it is true to say that the relative or friend is not “entitled to indemnity under any other policy” within the meaning of the Road Transport policy, and not “afforded” indemnity “by any other insurance” within the meaning of the Cornhill policy, when the other policy negatives liability where there are two policies. At that point the process must cease. If one proceeds to apply the same argument to the other policy and lets that re-act upon the policy under construction, one would reach the absurd result that whichever policy one looks at it is always the other one which is effective.’

[1235] Commercial Union Assurance Co Ltd v Hayden [1977] QB 804 (CA) [A firm was covered for public liability under a policy with Commercial Union up to a limit of £100,000 and with the defendant, Lloyd’s underwriters, up to £10,000. Both policies contained a rateable proportion clause. A claim for £4,425 was paid by Commercial Union, and the issue concerned the method for calculating the contribution the underwriters should make.] Cairns LJ: ‘The wording of the rateable proportion clause was substantially the same in the two policies and it is sufficient to quote the one in the plaintiffs’ policy: “If at the time of any claim arising under this section there shall be any other insurance covering the same risk or any

part thereof the company shall not be liable for more than its rateable proportion thereof.” The defendant’s contention, which succeeded before the judge, was that the apportionment should be on what has been called a ‘maximum liability’ basis. Since the maximum liability of the plaintiffs was £100,000 and that of the defendant was £10,000, that basis would result in the plaintiffs paying 10/11 of every claim whatever its amount. The plaintiffs’ contention was that a basis described as an “independent liability” basis should be adopted, ie, that it should first be ascertained what would have been the liability of each insurer if it had been the only insurer and the total liability to the assured should be divided in proportion to those independent liabilities, so that on these two policies any claim up to £10,000 would be borne equally, but on a claim for, say, £40,000 the plaintiffs’ independent liability would be £40,000 and the defendant’s liability would be limited to £10,000, so that the apportionment would be in the ratio of 4:1, ie, £32,000 to be paid by the plaintiffs and £8,000 by the defendant. …The problem is primarily one of construction of the clauses in the policies, because it is common ground that the fraction of his total claim that the assured could recover from each insurer is the fraction which that insurer must bear as between itself and the other insurer. It cannot be said that as a matter of language either construction is preferable to the other. There is no English authority which is directly in point and such decisions on apportionment between insurers as have been cited — two in England, two in Scotland, two in Canada and four in the United States — shed only an uncertain light on the problem. …I am not persuaded that the same basis should apply to liability insurance as to property insurance…In property insurance the insurer insures the property for a stated sum,

which is normally supposed to represent the value of the property…In liability insurance there is no corresponding ‘value’ to which the limit (if any) of the insurer’s liability is related. …The issue being one of construction and the language being, as it seems to me, equally capable of either suggested meaning, I ask myself which meaning is that more likely to be intended by reasonable businessmen. The documents to be construed are policies, the parties to each of which are an assured and an insurer. It is not to be supposed that when either policy is issued the insurer knows that there is, or is going to be, another policy covering the same risk. Each limit of liability and each premium may be taken to be fixed without knowledge of the limit under any other policy that may have been, or is going to be, issued. It is difficult to suppose that when a limit of £10,000 was fixed by the defendant, it could have been intended that if there happened to be another policy with a limit of £100,000, the defendant should be liable for only one-eleventh of any claim, however small. The independent liability basis is much more realistic in its results. In the case of these two policies, any loss up to £10,000 would be shared equally, and it is only with larger losses that the proportion of the plaintiff’s share to the defendant’s share steadily increases until, with a loss of £110,000 or more, 10/11ths of the liability falls on the plaintiffs. The obvious purpose of having a limit of liability under an insurance policy is to protect the insurer from the effect of exceptionally large claims: it seems to me artificial to use the limits under two policies to adjust liability in respect of claims which are within the limits of either policy.’

[1236] Republic Underwriters Ins Co v Fire Insurance Exchange 655 P2d 544 (Supreme Court of Oklahoma, 1982)

Hargrave J: [with whom the majority concurred] ‘…The insured parties, Robert and Fawn Sloan, moved from a Tulsa rental residence to Inola, Oklahoma. Within three weeks that residence was destroyed by fire. At the time of loss, the unscheduled personal property of insureds was covered by two policies. Republic Underwriters’ insurance policy had a property coverage limit of $10,000 and a living expense limit of $4,000. Fire Insurance Exchange had issued a policy with limits of $15,000 unscheduled property and a living expense limit of $3,000. Notice of loss was received by plaintiff [Republic] on 21 August 1973; the cause and loss were verified by plaintiff’s agent. Payment was made by plaintiff to insureds in the sum of $10,000 for unscheduled personal property, and $701.85 for additional living expense. The payments were necessary and reasonable, resulting from perils insured against in the contracts of both insurers. After proof of loss was furnished by insureds, defendant denied liability and made no payment as a result of the loss. In this action, plaintiff makes demand on defendant for a pro-rata reimbursement; previous demand was refused. …[It was argued by the appellant, Republic] that when each of several insurance policies cover the same risk and contain a pro rata clause, the several contracts are independent and each insurer binds itself to pay its own proportion of the loss and there is no right of contribution in favor of either insurer. The pro rata clause [‘This company shall not be liable for a greater portion of any loss than the amount hereby insured shall bear to the whole insurance covering the property against the peril involved, whether collectable or not.’] dealt with here attempts to limit insurance coverage to a proportionate part of the contract to all insurance covering the loss whether the other insurance is collectable or not.

A simple reading of the pro rata clause demonstrates the insurer did bind itself to pay its proportionate share of the loss. Despite this fact, the appellant contends the appellee should be considered a volunteer as to its payment over the proportionate amount, and should be left with the comforting maxim that the law will not aid a volunteer as a response to its attempt to enforce a proportionate share of the loss upon appellant as provided in the contract. In support of this attempt to skirt the contractual obligation to pay a proportionate share of the loss, Commercial Union Ins Co of New York v Farmers Mutual Fire Ins Co, 457 SW2d 224 (Mo App1970) is cited as follows, although appellant admits Oklahoma has not embraced this theory: “…On the other hand, if the several insurers restrict their obligation by agreeing to pay only that proportion of the loss as the amount insured by the respective insurers bears to the total insurance covering the property against the peril involved, then none of them has a right of contribution against the others because each contract is independent of the other contracts.” Irrespective of this authority which limits contribution rights to contracts evincing a common or concurrent liability, this Court is unwilling to impede early payment of an insured’s loss by characterising the carrier paying the full loss as a volunteer in the event it is later determined that there existed more than one insurance contract. The doctrine of legal subrogation as recognized in this state is broad enough to place the responsibility for payment where it should, in equity and good conscience, finally repose, and the trial court correctly so held. The principle of legal subrogation has been characterized in this jurisdiction as a classic remedy in equity; a fluid concept depending on each case’s facts and circumstances based upon the natural justice of placing the ultimate responsibility for a loss where

it ought finally to repose without the form of a rigid rule of law. Lawyers’Title Guaranty Fund v Sanders, supra. Subrogation is a creature of equity intended to achieve the natural justice of placing the burden where it ought to rest, and unlike a fixed rule of law, subrogation is pliable and capable of being molded to attain justice to compel the ultimate discharge of a debt or obligation by the party who in good conscience ought to pay it. Mid America Trailer Sales Inc v Moorman, 576 P2d 1194 (Okl App 1977). The observation made above that appellant contracted to pay his proportionate share of the loss determines that the ultimate responsibility for that proportion should be transferred ultimately to its shoulders.’

[1237] D Friedmann ‘Double Insurance and Payment of Another’s Debt’ (1993) 109 LQR 51 ‘Where the same interest is covered against the same risk under two indemnity insurances, each for the whole value of that interest, the insured is entitled, in case of a loss, to payment in full from any of his insurers, but he may not recover an amount exceeding his loss. The insurer who pays the whole amount due relieves the other from his liability to the insured, while the rights of the insurers inter se are adjusted ex lege by the doctrine of contribution. Insurance companies are apparently not content to leave these just and fair rules as they are. The result is often unhappy and sometimes backfires. Legal & General Assurance Society Ltd v Drake Insurance Co Ltd [1992] 2 WLR 157 provides an example. The facts were as follows. The insured was driving his car when he collided with a pedestrian (the third party). The insured’s liability was covered by two policies. One had been issued by the plaintiffs for a period of one year. The second policy,

issued by the defendants, covered only one month within that year. This was the month in which the accident occurred. The insured turned to the plaintiffs and failed to notify the defendants of the accident. The plaintiffs reasonably settled the third party’s claim for £65,000 plus costs and claimed contribution from the other insurer. The Court of Appeal dismissed the claim and held that in view of a “rateable proportion” clause in the plaintiffs’ policy they were only liable for half of the insured’s loss. Payment of the excess was, therefore, voluntary and could not be recovered by way of contribution. The decision raises a number of interesting points. (1) “Other insurance” exclusion and “rateable proportion” clauses Where an insured has covered his whole interest with one insurer, there is, generally, no need for him to acquire an additional coverage for the same interest. If he nevertheless does so, he merely provides a benefit to the original insurer, who will be able to shift, through the doctrine of contribution, part of the loss to the second insurer. The premium for the new insurance paid by the insured will thus enure to the benefit of the insurer. The insurer has normally no right to expect that another party will share his liability, and from his point of view the right of contribution is a pure windfall. Insurance companies are still not content and insert in their policies clauses intended to grant them additional advantages. The “other insurance” exclusion provides in essence that liability towards the insured is excluded if there is any other insurance covering the same loss. The “rateable proportion” clause provides that if there is another insurance, liability, though not altogether excluded, is to be limited to the insurer’s share in the loss. These clauses have a number of features in common. (a) Both intend to deprive the insured of the only potential advantage of double insurance

acquired by paying additional premium, ie that of having the choice against which insurer to proceed. (b) Both intend to eliminate the multiple debtors situation. The “other insurance” exclusion aims at leaving the insured with but one debtor (instead of two). The “rateable proportion” clause splits the liability of the insurers, so that each covers only part of the loss. The two insurers remain liable, but there is no overlapping liability. In order to recover the whole amount due, the insured must call upon both. (c) In the absence of a multiple debtors situation there is, of course, no room for contribution. In the case of “other insurance” exclusion, only one insurer is liable. In the case of “rateable proportion” clauses the obligations of the insurers are cumulative. Both clauses are detrimental to the insured. By eliminating the multiple debtors situation, the risk of insolvency of one of the insurers is shifted to the insured. This at least seems the position of English law (MacGillivray and Parkington, Insurance Law 8th edn), p 772, in the context of rateable proportion. Other legal systems adopt a different approach: D Friedmann and N Cohen, “Adjustment Among Multiple Debtors,” International Encyclopedia of Comparative Law, Vol X, Chap 11, p 4, n 4). The result is most unsatisfactory. Why should the risk of insolvency of one insurer be imposed on the insured when the premium which the other insurer received was calculated on a full liability basis and when the insurer had no right to expect that another party would share the obligation? There are other disadvantages from the insured’s point of view. In fact, these clauses cast upon him the whole burden resulting from the complexities of a three party situation. Suppose the liability of insurer A is clear but that of B is in doubt and B denies liability. Under the general principles the insured could recover the whole loss from A and leave the issue of B’s liability to be decided in a contribution claim by A against B. However, if A’s policy contains “other

insurance” exclusion or a “rateable proportion” clause, the burden of litigating with B will be imposed upon the insured. Moreover, the difficulties with B will project upon the insured’s rights against A. If B is free from liability, A is liable in full. If, on the other hand, B is liable, then A is either free from liability or his liability is proportionately reduced. Consequently, the insured may not be able to recover from A until his position vis-à-vis B is clarified. The result of the “other insurance” exclusion and “rateable proportion” clauses seems to be that the more insurance one acquires the less protection one gets. This becomes particularly conspicuous where two policies each contain an “other insurance” clause which attempts to exclude liability if the insured is covered elsewhere. Fortunately, rather than reaching the absurd result that the insured is covered nowhere, it was concluded that the clauses cancel each other out (Weddell v Road Transport and General Insurance Co [1932] 2 KB 563). However, “rateable proportion” clauses in the two policies remain valid. Insurance companies may find them advantageous, though from a broader point of view they are not necessarily so. In any event, their adverse effect on the insured cannot be doubted. In Legal & General v Drake the rateable proportion clause acted as a boomerang. Contribution was denied to the plaintiffs who acted most properly in voluntarily paying more than their share. It would have been better not to include a rateable proportion clause in the first place and thus avoid the need to seek to disregard it later. (2) Rateable proportion clause and payment of another’s debt Where a number of persons are potentially liable to the plaintiff, some of them may have a strong interest in settling the claim. There is also a public interest in facilitating settlement. However, a serious difficulty arises if it transpires that the party who satisfied the plaintiffs claim

was not actually liable to him. In such a case the rules as to adjustment among multiple debtors are inapplicable, since the payor was not a “debtor”. The issue is then channelled to the general problem of payment of another’s debt (Friedmann and Cohen, above, at pp 22–25) and the reasonable solution is to allow the payor to recover from the real debtors. English law is not, however, very benevolent to a party who without being requested confers a benefit upon another, and since the payor did not act under legal compulsion, he may well be branded as “volunteer.” The possibility of relaxing the volunteer rule, in the context of payment of another’s debt, has been widely discussed. Goff and Jones, The Law of Restitution (3rd edn), at p 529 suggest that a person who pays another’s debt in order to discharge a moral duty is not officious. The majority of American decisions supports the proposition that an insurer who has paid the insured in full is entitled to recovery from another insurer who covered the same interest despite a rateable proportion clause (Palmer, The Law of Restitution (1978), Vol 2, pp 405–06; Republic Underwriters Ins Co v Fire Insurance Exchange 655 P2d 544 (1982)). Even the decision in Owen v Tate [1976] QB 402 (CA) which actually represents the strict approach, contains statements indicating potential flexibility. None of this is mentioned in Legal & General v Drake. In fact, once it was found that the rateable proportion clause limited the plaintiffs’ liability to 50 per cent of the loss, it was held as a matter of course that payment was voluntary. The fact that the plaintiffs acted most properly was considered of no moment. To allow recovery would “extend the equitable doctrine of contribution beyond any previous authority” (at p 164). However, because of the rateable proportion clauses there was no overlapping liability. No question of contribution arose and the issue should have been analysed in the context of payment of another’s debt.

… (4) Failure to give notice As already mentioned, the insured failed to notify the defendants in time of the accident. Under the terms of their policy this afforded the defendants a perfect defence against his claim. How does it affect the plaintiffs’ position? Much of the decision was devoted to this point although eventually it was the rateable proportion clause which proved decisive. The majority (Lloyd and Nourse LJJ, Ralph Gibson LJ dissenting) held that the failure to give notice after the accident did not affect the right of contribution. For the purpose of our discussion it is convenient to distinguish between the case in which the claim is for contribution from a co-debtor and that in which it is (because of the rateable proportion clause) based simply on payment of another’s debt. In the context of multiple debtors the question relates to the effect on contribution of a defence available to a codebtor against the common creditor. The issue is a complex one (see, generally, Weir, above, at pp 47 et seq, 65 et seq; Friedmann and Cohen, above, at pp 27 et seq) and I shall merely point out some of the relevant considerations. These include the “strength” of the equity of contribution, and the nature of the defence, as well as the question whether it is an initial defence (namely a defence already existing at the time when liability accrued) or a subsequent one. Regarding the equity of contribution, the present instance belongs to the category which is the weakest (Friedmann and Cohen, supra, especially ss 28, 30, 36, 51). The right to contribution should be most zealously protected where the debtors in undertaking the obligation relied on each other, as, eg where two sureties jointly agree to guarantee the same debt. The equity of contribution is much weaker where the sureties independently guaranteed the same debt or where two insurers independently covered the same loss. In this

category neither of the debtors had a right to expect that the other would share the obligation, nor was the other responsible for the formation of the obligations. Consequently, if one of the co-debtors has a “strong” defence against the creditor it should also shield him from a contribution claim, even if the defence is a subsequent one. Thus, suppose that in the case of double insurance the insured’s claim against one insurer is dismissed. It is submitted that the judgment dismissing the claim, although technically no res judicata against the other debtor, should offer protection from the latter’s contribution claim, provided that the creditor’s action was conducted in good faith (cf also the questions which arise in case of a compromise with one of the debtors: Friedmann and Cohen, above, at pp 42–43). However, the equity of the defendants’ defence in Legal & General v Drake was weak. Failure to give notice in time is a subsequent defence and under the circumstances seems a highly technical one. It is unlikely that the absence of notice had in any way prejudiced the defendants. Therefore, the majority approach under which breach by the insured of the notice requirement provides no defence against a contribution claim is preferable. There is another aspect to this issue. It seems that the court assumed that but for the rateable contribution clause the insured had no reason to notify the defendants of the accident (at p 160, per Lloyd LJ). But if failure to give notice is fatal to contribution (as Ralph Gibson LJ concluded in his dissent), then the plaintiffs could arguably claim that the insured had wrongfully deprived them of their equity of contribution (cf Ward v National Bank of New Zealand Ltd (1883) 8 App Cas 755; Goff and Jones, above, at p 283). Hence, the insured will not be adversely affected by his failure to give notice only if it is assumed such failure does not extinguish the right of contribution. The defence issue becomes more problematical if the claim is based not upon the right of contribution between

co-debtors, but simply on the payment of another’s debt (see (2) above). As already indicated, this latter avenue should have been open to the plaintiffs, whose contribution claim was defeated by the rateable proportion clause. Of course, the issue of defence arises only if a right of recovery, based upon the payment of another’s debt, is in principle recognised. The point was not considered in Legal & General v Drake in which it was apparently assumed that no such right exists. If, however, such right is in principle recognised, then arguably it should be subject to defences available to the obligor at the time of payment. At this time the insured had already forfeited his rights under the defendant’s policy. The defence was highly technical, but the defendants could argue that when the plaintiffs made their payment there was no debt owed by them to the insured. (5) Effect of the Road Traffic Act 1972 Under the Act both the plaintiffs and the defendants were required to satisfy judgment obtained by the third party against their insured. Neither the rateable proportion clause nor the failure of the insured to give notice in time afford a defence against such liability (ss 148(2) and 149 of the Act). There were, thus, two creditors, the insured and the third party. The latter was the one primarily entitled to payment. Since the rateable proportion clauses were ineffective against the third party, the liabilities vis-à-vis this party were overlapping. Each insurer was fully liable to him and payment by the one relieved the other from liability. The doctrine of contribution was thus applicable. Nevertheless, the court held that no contribution could be had since under the Act the insurer can recover from his insured the amount he was compelled to pay the third party and which exceeded his liability to the insured. In view of the rateable proportion clause the plaintiffs were entitled to recover from the insured 50 per cent of the payment made

to the third party. The net liability to the insured remained limited to 50 per cent and payment in excess was, thus, “voluntary” (ibid at p 164). The point was only briefly discussed, and little was said about the prospects of actual recovery from the insured, though Ralph Gibson LJ mentioned that the plaintiffs could obtain the excess from their insured “subject to his ability to pay” (at p 172). It is submitted that the bare right of recovery from the insured should not have defeated contribution. The third party had three debtors, each liable to him in full: the insured, the plaintiffs and the defendants. In their internal relations the position of the debtors was as follows. Between the insured and the plaintiffs each was primarily liable for 50 per cent of the damages and secondarily liable for the other 50 per cent (because of the rateable proportion clause). Between the insured and the defendants, the insured was the party primarily liable (because of the failure to give notice). Does the fact that one of the debtors is primarily liable exclude contribution from debtors who are secondarily liable? The answer is clearly negative. Otherwise contribution between co-sureties would never be allowed. Indeed, the general principle is that the bare right of indemnity which a surety has against the principal does not exclude contribution from a co-surety. There is, however, a procedural limitation. Ordinarily the contribution claim may not be brought unless the principal is joined as a party or it can be shown that he is insolvent. This, however, is a mere rule of convenience aimed at avoiding multiplicity of actions (Goff and Jones, above, at pp 277–78). It is not a condition precedent (Hay v Carter (1935] Ch 397). It is submitted that on this matter a liberal approach should be adopted. Contribution from a party secondarily liable should be allowed not only where the principal debtor is insolvent, but whenever there are sufficiently good reasons not to direct the claim against him. In the present context an insurer may be perfectly justified in abstaining from bringing such a

claim which is unlikely to enhance his reputation. Rather than suggesting that the plaintiffs could go against their insured, it would have been preferable to make the defendants contribute and leave it to them to pursue the claim against the insured, if they were minded to do so.’

13 Indemnity and Reinstatement 13.1 The Principle of Indemnity There is an obvious symbiosis between the indemnity principle and the insurable interest requirement. Indemnity, which underpins insurance law generally, limits the liability of an insurer to the actual loss suffered by the insured (see section 3 of the Life Assurance Act 1774, chapters 6 and 7 above), less any excess that the insured has agreed to bear. If the insured is paid a sum greater than that which represents the loss so that he or she profits the indemnity principle is violated. In indemnity insurance the insured must prove not only the occurrence of the insured risk, for example fire, but also that he or she has suffered a pecuniary loss as a consequence. Where a policy is ‘unvalued’ the insured can claim only the amount of the loss. This is calculated by determining the difference between the value of the insured property immediately before the loss and its value immediately after the loss. Where a ‘sum insured’ is specified this represents the maximum figure which

the insured can recover: “[y]ou 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” (Chapman v Pole (1870) 22 LT 306, per Cockburn CJ). However, where the policy is ‘valued’, the insured can recover the full sum where the subject-matter of the insurance is totally destroyed notwithstanding that this results in a windfall payment because the subject matter was over insured. Similarly, if there is a partial loss, the insured can claim the proportion of the agreed value which represents the proportion of the damage to the insured property. As we will see below, valued policies fall outwith the indemnity principle. As has been seen in chapters 6 and 7, insurable interest refers to the interest an insured is required by law to have in the property or life that is the subject of the policy. If the insured lacks the requisite interest then he or she suffers no loss and any payment would therefore violate the indemnity principle. Any definition which seeks to encompass both insurable interest and the indemnity principle necessarily becomes tautological. It is noteworthy that where insurable interest is determined by reference to economic interest in the insured property, insurable interest becomes subsumed within the indemnity principle. If the insured property is economically useless insurable interest may be extinguished:

[1301] Chicago Title & Trust Co v United States Fidelity & Guaranty Co 376 F Supp 767 (1973) [The facts appear from the judgment]. Will J: ‘In the instant case, when the subject building was destroyed on May 1, 1972, it was an economically useless building. It was empty, secured and boarded. It had been gutted by a previous fire. It was not being used in any way. Here, as in Aetna State Bank v Maryland Casualty Co, 345 F Supp 903 (ND Ill 1972), it would be ludicrous to allow the plaintiff to recover a substantial amount of money representing the replacement cost less depreciation of a building that was for all practical purposes non-existent. It would be grossly inequitable for plaintiff’s beneficiary to recover $43,000 for a building which less than one month prior to its destruction she had purchased for $4,000 in what appears to have been an arm’s length transaction and in which building she had made absolutely no additional investment or improvements. We hold that the Smith v Allemannia Fire Ins Co, [219 Ill App 506 (1920)] doctrine of rigidly defining actual cash value of a building as its reproduction costs minus depreciation is limited in application to those buildings which are being economically utilised at the time of their damage or destruction. Such a limitation may be implied from the facts of those cases which have purported to follow Smith. Despite the language in the various opinions, Illinois had not allowed such windfalls as plaintiff here seeks. Illustrative of this is the recent case of Lieberman v Hartford Ins Co, 6 Ill App 3d 948, 287 NE 2d 38 (1st Dist 1972), in which the Appellate Court of Illinois went a step further than Judge Marovitz in Aetna State Bank and held that, where a contract for demolition exists on the subject

building, the plaintiff has no “insurable interest” in the building since there is no economic value to the building. Judgment was entered for the defendant in that case despite clear liability under the policy. In the instant case, the building was economically useless at the time of the fire. While we would prefer a more flexible standard of insurable “actual cash value” than the Illinois courts have adopted so that, in cases like the instant one, an insurable interest having some relationship to the actual value, even though nominal, could be found, we conclude that under all the precedents, there was no insurable interest in the building at the time of the fire on 1 May 1972. In cases such as the instant one, where the building is vacant, boarded up and under a court order prohibiting repair of its heating system, and, therefore, cannot be economically utilised, reproduction cost new less depreciation has little or no relationship to actual value. Other factors, such as market value or salvage value, should be considered in establishing any insurable interest of the building owner. In their present posture, however, the Illinois cases preclude consideration of such factors. They do, however, permit a finding that where, as here, a building is economically useless and was obviously purchased for its scrap or salvage value, there is no insurable interest. This is such a case…’

Notes: 1. The indemnity principle does not operate in contingency insurance, for example life and accident policies, where the sum recovered is fixed by the terms of the policy. Thus, in life assurance there is no upper limit on an insured insuring his or her own life. Property insurance, however, is a prime example of a contract of

indemnity. The measure of indemnity is the cost of reinstatement. Insuring the structure of a house worth £100,000 for £200,000 will not result in a windfall for the insured in the event of its total destruction. If rebuilding costs are £80,000 then that is the sum which is payable in order to achieve indemnification. The land upon which the house stood is still in existence and the insured has no need to go back into the market to buy another plot. Nor can the insured in our example avoid the indemnity principle by insuring with several companies and making multiple claims for full amount. If one insurer pays then they can bring an action for a contribution from the co-insurers (see chapter 12). 2. As indicated above, the parties may contract out of the indemnity principle by predetermining the sum payable in the event of a loss irrespective of the actual value of the property at that time (see Kuwait Airways Corp v Kuwait Insurance Co SAK [2000] Lloyd’s Rep IR 439). Such contracts are termed valued policies and are common in marine insurance — an appropriate analogy is liquidated damages. A stated value is not conclusive, although the courts have shown greater willingness to find a valued policy where the property’s value might otherwise be difficult to determine. Where there is a partial loss the insured will recover a sum in proportion to the stated value. This is assessed by taking the ratio of the actual value

of the property after loss to the actual value of the property before the loss. [1302] Goole and Hull Steam Towing Co Ltd v Ocean Marine Insurance Co Ltd [1928] 1 KB 589 Mackinnon J: ‘[a valued policy is] not a contract of indemnity ideally, but of an indemnity according to the conventional terms of the bargain. When a loss has happened the question is hardly ever: How much is the assured out of pocket? That might be the proper question if the object of the contract was to provide an ideal indemnity. The real question in any case is: What is the measure of indemnity that by the convention of the parties has been promised to the assured?’

Note: Complex valuation problems arise where the subject matter of the insurance is unique and the parties have not opted for a valued policy. A particular difficulty is that where the subject-matter of the unvalued policy is, for example, a work of art it is impossible obtain an objective market valuation: [1303] Quorum AS v Schramm [2002] 1 Lloyd’s Rep 249 [The insured property was a Degas pastel, La Danse Grecque. It 1989 it was purchased by Mayfair Fine Art for some $4.3m which was based on an auction estimate of $4.5–$5m. In 1990 the painting was

valued at between $4–£5m. Mayfair, having tried unsuccessfully to resell it, placed the painting in storage. In October 1991 a fire occurred at the warehouse where the painting was stored. Notwithstanding that it was placed in a strong room with a steel door that protected it from the fire itself, the painting suffered damage due to the heat and change in humidity. After restoration work it was sold in June 1995 for $3.275m although Mayfair received only $2.7m after commission had been taken into account. In September 1997 legal proceedings were brought against the insurers. The insurance policy stated the valuation to be ‘Original cost price to the asssured. Plus 20 per cent or market value at the time loss or damage is sustained whichever is the greater.’ The policy was later endorsed to include La Danse Grecque with a sum insured of $5.3m. After the fire, the parties negotiated a new endorsement to the policy governing partial loss: “In the event of partial loss or damage…the amount of the loss shall be the cost and expense of restoration plus any resulting depreciation in value. Underwriters’ liability shall be limited to that proportion of such loss or damage which the sum insured bears to the market value of the item immediately prior to the loss and in no event shall underwriters be liable for more than the insured value of the Item.”

The issues for determination by the court were: (1) whether the policy was valued or unvalued; if unvalued what was the effect of the endorsement; (2)

the extent of damage sustained; and (3) the value of the painting before the fire and its value after the fire]. Thomas J: ‘Issue (1): Was the policy a valued policy? It was also common ground that I should construe the policy as a whole (including both the endorsements) in the light of the principles applicable. In Kyzuna Investments Ltd v Ocean Marine Mutual Insurance Association (Europe), [2000] 1 Lloyd’s Rep 505, I endeavoured to summarise at p 508 the principles applicable to determining whether a policy of marine insurance was a valued or unvalued policy. Those principles are also generally applicable to non marine insurance; in para (5) of my summary in Kyzuna, I referred to the fact that it is common for a policy of marine insurance to be a valued policy and set out the reasons for that. As regards non-marine insurance, a passage at paras 28–7 of Professor Clarke’s The Law of Insurance Contracts (1999 edition) is helpful. “A policy is more likely to be construed as a valued policy in cases in which a valued policy is most useful, such as the insurance of property the value of which fluctuates or is a matter of debate or in cases in which it may be difficult to assess the amount of the loss.” However it is important to bear in mind that there is an accepted and well known distinction between an insured value and a sum insured: The use of the term “sum insured” will normally indicate the amount for which the subject matter is insured and will not be read as an agreed value. There are a number of authorities that make this clear. (See Kyzuna at p 509)… Although the clause relating to La Danse Grecque refers to the sum of US $5.3 m., it does not do so in terms of value.

Although I see the force of the argument made by the claimant that one would ordinarily have expected the parties to agree a value for a work of the importance and value of La Danse Grecque, the parties did not do so. Although they did not use the words “valued at”, that is clearly not decisive as any language can be used. However, they expressly used the words “in addition to the policy limits hereon, including while anywhere within the geographic limits of this policy”. It seems to me clear that they were adding this picture as an additional work with a further policy limit, though expressed in dollars…There are no words that stipulate that this is an agreed value. Furthermore the words of cover in the policy are expressed in terms of “up to the amounts stated”; the clause adding La Danse Grecque did not use any words to modify that basic provision. The endorsement agreed on 17 January 1992 applied from inception. Although therefore as a matter of context and timing, it was agreed after the loss, it was to apply from inception. It was therefore common ground that I should construe it as if it had always been part of the policy. The clause was, however, ambiguous and contained a clear contradiction in the terms used in the second sentence. This is somewhat remarkable, given the fact that it was agreed after the loss and was intended to deal with it. The first sentence was clear; the amount recoverable was the cost of restoration and the resulting depreciation in value. The second sentence then purported to limit the recovery by reference first to the proportion the “sum insured” bore to the market value immediately prior to the loss, with a cap of the “insured value” of the item. Both parties contended that in the second sentence, the parties could not sensibly have intended to refer to both the sum insured and the insured value; both references must have been either to the one or the other. The claimant contended

that both references must be read as being to insured value… It is unfortunate that after the loss the parties should have agreed a clause that is so unclear. On the claimant’s submissions this partial loss clause had the effect of confirming the policy as a valued policy after the loss; on the underwriters’ case it introduced an average clause of a most unusual kind at that point in time. However, as I have said, it is common ground that I must construe the clause as if it had always been part of the policy. Approaching the policy as a whole, including the partial loss clause, I do not consider it to be a valued policy. I have already considered the other terms of the policy. The first sentence of the partial loss clause is the primary measure of recovery; on its ordinary language, it is to be read as referring to depreciation in value in terms of market value. This sentence therefore does not point to the policy being a valued policy, though it is not inconsistent with it being a valued policy. Thus the second sentence is crucial to the claimant’s argument; the difficulty is that the operative words that would apply the principles of a valued policy are expressed in terms of “the sum insured” and if I were to read those words as “insured value of the item”, I would not only be making a major interpolation, but the last phrase in that sentence would have no purpose. Furthermore the terms of the partial loss clause would not obviate the need for an enquiry into the market value; it would be a little unusual to find therefore the decisive terminology in such a clause. In my view, less violence is done to the language and a greater consistency is achieved by reading “sum insured” to mean, as it says, sum insured. The clause would then operate as an average clause. However this leaves the difficulty that it would operate, on its literal language to reduce the recovery if the market value had fallen below the sum insured; this was not a result for which underwriters contended and it is wholly so uncommercial that the result

cannot have been intended…the second sentence of the partial loss clause was plainly intended to operate only where the market value had risen and had no application where it had fallen. In the result therefore I have concluded that this was not a valued policy. Issue (2) What damage did the pastel sustain which is recoverable under the policy? [This was an issue of expert evidence.] Underwriters contended that apart from the paper tears and bowing of the board (which they accepted to be direct physical damage), there was no other direct physical damage. I do not agree with that submission on the facts of this case as I have found them to be. I accept that depreciation in value because of the suspicion of possible physical damage is not covered; I also accept that indirect physical damage is not covered. However, I have found that there was sub- molecular damage to the pastel caused by the fire; that was, in my view, damage to the picture. In my view such damage is clearly direct physical damage resulting from the fire, even though it might not be visible and its extent could not be determined without testing which could not be carried out because of its effects on the pastel… The sub-molecular change gives rise to the shortening of the life of the pastel and the risk of deterioration. As time passes and no deterioration occurs, the risk must become less, but I have to assess that risk at the time the damaged value has to be ascertained immediately after the fire. Furthermore it seems to me clear that in assessing the diminution in value of the picture, I must take into account the view which the market would take of the value of the picture with the physical damage I have found existed. It may well be that the market attributes to such damage a much greater monetary effect than a detached and rational analysis might suggest; however, it is common place that in the case of more prosaic goods that have suffered minor

damage (such as damaged cargo), the diminution in value might in consequence be greater than might at first sight be assumed, because of the view taken by the market of such goods. That is a function of the market’s view of the value of goods which have suffered damage as a result of an insured peril; it is not a separate element of “stigma”.

Issue (3): The value before and after the fire There was very little authority that Counsel could find, despite extensive research, on the approach to the valuation of a work such as La Danse Grecque. I consider that the task of the Court is to ascertain the price that could be achieved between a willing seller and a willing buyer within a reasonable period of time in the relevant market or markets; if there is an open market price, that should be ascertained. That test is, it seems to me, consistent with the approach taken in relation to the sale of goods…the approach to valuation under many statutes (such as s 160 of the Inheritance Tax Act and corresponding provisions of other revenue statutes, s 9 of the Leasehold Reform Act, 1967 and s 459 of the Companies Act, 1985), the observation of Colman J at p 24 of his judgment in The Timbuktu [2001] 1 Lloyd’s Rep 739 and the general guidance by the Royal Institute of Chartered Surveyors as to the basis for valuations conducted by them. In assessing the value, I should take into account whatever evidence is available: see Professor Clarke’s The Law of Insurance para 28–3B. That will include evidence of prices obtained at auctions: see Luxmoore-May v Messenger May Baverstock [1990] 1 WLR 1010 at pp 1026–1027… On the basis of [the] authorities [three tax cases: Holden v IRC [1974] 2 All ER 819; Holt v IRC [1947] 1 All ER 148; and Mouat v Betts Motors [1959] AC 71] it seems to me that I ought to have regard to the market where it was likely that the higher price would be obtained — the dealers’ market. Furthermore that was the market where the claimant was

more likely to sell the picture and therefore it more accurately reflected the loss against which the claimant is entitled to be indemnified. If, on the facts, it was clear that the claimant would have used the market where the price was likely to be lower, the position might be different, but on the facts of this case, I am satisfied that in October, 1991 the claimant…were going to sell on the dealers’ market. However the dealers’ market and the auction market did not operate in isolation and it is relevant to take into account the available evidence in relation to both. The commissions in the market for works of art of this value are very large indeed — whether the sale is by auction or through a dealer. Should they be taken into account? In my view they should not be. Commissions are not normally taken into account in valuations and I see no reason to do so in this market. It was common ground that there was no market for the damaged pastel. In the circumstances, I will follow the approach suggested by Devlin J in Biggin & Co v Permanite Ltd [1951] 1 KB 422…He observed that one could rarely arrive at an accurate figure of damaged value; in the absence of precise evidence “the court must do the best it can” [taking into account expert evidence]… I am quite satisfied that the picture had a value in excess of US $3 m. but not greater than US $4 m. in the sense of the price likely or reasonably expected to be obtained between a willing seller and a willing buyer. Doing the best I can in what is a very difficult area of assessing value, I consider that the value was towards the higher end of that bracket; for example a prospective buyer was unlikely to have indicated an offer in the region of US $3 m. if he was not willing to go higher. In my assessment, taking all these factors into account, I have come to the conclusion that the value was US $3.6 m on the dealers’ market immediately preceding the fire.

The damaged value after the fire Mr Roundell assessed the depreciation as 20 per cent; Mr Dauberville at 80 per cent. if assessed immediately and 55 per cent. if assessed in March, 1992. The difference between them was large and no doubt reflected the difficulty of assessing the depreciated value and their lack of experience in selling works of this value that were damaged… I am also satisfied that the range of those interested in the picture in its damaged state would have been fewer; although there were dealers who would have been prepared to market it, a large number would not. Furthermore, the number of museums and serious collectors likely to be interested would have been few; I consider the evidence of Mr Dauberville was correct on this point. In valuing the picture after the fire, I must look at the risks of further deterioration as they might have been assessed at the time (on the assumption that restoration work had been carried out). Even allowing for the few months that had elapsed by the end of that, it would have been difficult to assess what long term effect the sub-molecular damage might have had. On the other hand, I have to treat Mr Dauberville’s figures of 80 per cent. (if put on the market in 1991) and 55 per cent. (given in April, 1992) with some caution. He plainly had no actual experience of selling such works in a damaged state… Doing the best I can and taking into account the fact that I am dealing with a work of very high value, considering that the uncertainty present in October 1991 (allowing a few months for conservation and thus time to see if any of the sub-molecular damage had manifested itself) and taking into account that Mr Dauberville’s figure was given in April, 1992, I consider that its value in its damaged state would have been US $2.2 m.

Conclusion I therefore conclude that the claimant is entitled to recover US$1.4 m under the policy of insurance.’

Note: Where there is a partial loss of goods or land the amount recoverable by the insured is generally based on the cost of reinstatement although to achieve a true indemnity figure a deduction may be made for betterment, ie. a discount may be applied to reflect the extent to which the reinstated property is better than it was before the loss. [1304] Reynolds v Phoenix Assurance Co Ltd [1978] 2 Lloyds Rep 440 [(For the non-disclosure issue which arose in this case, see chapter 4, [412]). Business premises (the maltings) which had been purchased for £18,000 were insured for £628,000 covering the buildings (£550,000), machinery (£28,000) and stock (£50,000). A fire occurred which destroyed some seven-tenths of the buildings. Exercising their right under the terms of the policy, the insurers elected not to reinstate. The claimants sought an indemnity which amounted to the cost of reinstatement of the buildings. The insurers argued that the claimants’ loss should be determined by the value of the buildings as used for the purposes intended by the plaintiffs, and that this should be measured either by market value or modern replacement value. Further, the insurers claimed that reinstatement, even if

genuinely intended by the claimants, was not appropriate because no commercial man would think of spending £1¼ million in rebuilding obsolete premises if he could buy modern premises for £30,000]. Forbes J: ‘The classic statement of the basis of the assured’s right to indemnity is to be found in the judgment of Brett LJ (as he then was) in Castellain v Preston, (1883) 11 QBD 380 at p 386: “The very foundation, in my opinion, of every rule which has been applied to insurance law is this, namely that the contract of insurance contained in a marine or fire policy is a contract of indemnity, and of indemnity only, and that this contract means that the assured, in case of a loss against which the policy has been made, shall be fully indemnified but shall never be more than fully indemnified. That is the fundamental principle of insurance, and if ever a proposition is brought forward which is at variance with it, that is to say, which either will prevent the assured from obtaining a full indemnity, or which will give to the assured more than a full indemnity, that proposition must certainly be wrong.” Mr Wilmers [counsel for defendant insurers] also relied strongly on a passage from the judgment of O’Connor LJ in Murphy v Wexford County Council (1921) 2 IR 230 at p 240: “You are not to enrich the party aggrieved; you are not to impoverish him; you are, so far as money can, to leave him in the same position as before. In dealing with buildings destroyed or injured, the following considerations suggest themselves — What sort of building was it? How was it actually used? Had it a possibility of a different use, a potential use which an ordinary owner might be reasonably

considered as likely to put it to hereafter? Would he for any reason that might appeal to an ordinary man in his position rebuild it if he got replacement damages or is his claim for such damages a mere pretence? And if he would rebuild what sort of a house would he put up? Would he rebuild on the same scale or would he adopt something else equally suitable to his requirements having regard to modern conditions?” Now Murphy’s case arose not under an insurance policy but under a statute giving compensation, to persons whose property had suffered malicious damage. The Court in that case was equating the measure of compensation with the measure of damages in ordinary civil cases: “…the law will endeavour so far as money can do it to place the injured person in the same position as if. the contract had been performed or before the occurrence of the tort…” [per Sir James Campbell, C at p 234]. A similar broad principle is apparent in the English law of compensation for compulsory acquisition: “…What it gives to the owner compelled to sell is compensation — the right to be put so far as money can do it in the same position as if his land had not been taken from him, in other words he gains the right to receive a money payment not less than the loss imposed on him in the public interest but on the other hand no greater.” [Per Lord Justice Scott in Horn v Sunderland Corporation, [194112 KB 26 at p 42]. But these are all broad principles — you are not to enrich or impoverish: the difficulty lies in deciding whether the award of a particular sum amounts to enrichment or impoverishment. This question cannot depend in my view

on an automatic or inevitable assumption that market value is the appropriate measure of the loss. Indeed in many, perhaps most cases, market value seems singularly inept, as its choice subsumes the proposition that the assured can be forced to go into the market (if there is one) and buy a replacement. But buildings are not like tons of coffee or bales of cloth or other commodities unless perhaps the owner is one who deals in real property. To force an owner who is not a property dealer to accept market value if he has no desire to go to market seems to me a conclusion to which one should not easily arrive. There must be many circumstances in which an assured should be entitled to say that he does not wish to go elsewhere and hence that his indemnity is not complete unless he is paid the reasonable cost of rebuilding the premises in situ. At the same time the cost of reinstatement cannot be taken as inevitably the proper measure of indemnity. There must be cases where no one in his right mind would contemplate rebuilding if he could re-establish himself elsewhere. The question of the proper measure of indemnity thus becomes a matter of fact and degree to be decided on the circumstances of each case. At this juncture it seems important to me to consider what in fact is; and was, the attitude of the plaintiff towards this building. Having seen them both in the witness box and heard not only their own evidence but other evidence too, I have reached certain firm conclusions on this matter. I am satisfied that they fully intended to use the maltings as a grain store and for the production of cattle feed. They were going to start in a small way and hoped to build up a business in time…They had bought an outstanding bargain when they secured the maltings for £16,000. I am quite satisfied that had they been faced with paying something over £50,000 for the maltings they would in all probability not have bought them; they would almost certainly have preferred a new Boulton and Paul building and the land to

put it on at the same price. At the same time I am quite satisfied that having bought them they not only intended using them for the purposes I have just described; they still so intend if the maltings are reconstructed. Further I feel satisfied that they genuinely intend to reconstruct the maltings if they receive a sum adequate to cover the cost of reasonable reconstruction. I am satisfied too, from their answers in evidence, that they could between them raise sufficient money to reconstruct even without the insurance moneys. I am not at all satisfied however that they would ever be sufficiently unwise to attempt to do so and certainly not to the old design and with the old type of material. They are both shrewd men of large resources. They could employ £¼ million more profitably than in rebuilding Stonham mattings. But they feel that, having insured the property for a very large sum on the advice of the insurers, they should be entitled to rebuild at the insurers’ expense, and not be forced to rebuild a replacement building elsewhere. Now Mr Wilmers argues that even if the plaintiffs have a genuine intention to reinstate you have to consider whether such an intention could be regarded as reasonable or merely eccentric. One can, I think, without doing him an injustice, expand this argument in this way, having regard to the views I have just expressed about the plaintiffs’ attitudes: if the plaintiffs were prepared to expend their own money on rebuilding it might be said that it had been shown that they were not being merely eccentric; but if they are only prepared to reconstruct if they get the insurance money to cover the cost then this demonstrates that the intention to rebuild, while genuine, is not that of a reasonable commercial person and therefore reconstruction is not the measure of indemnity…Now Mr Wilmers’ favourite case — Murphy — was a case of compensation where the owner was not being dispossessed, and the true view in such cases was expressed by O’Connor LJ in these terms:

“Would he, for any reason that would appeal to an ordinary man in his position, rebuild it if he got replacement damages, or is his claim for damages a mere pretence?” The upshot is that I am satisfied that the plaintiffs do have the genuine intention to reinstate if given the insurance moneys; that this is not a mere eccentricity but arises from the fact, as I find, that they will not be properly indemnified unless they are given the means to reinstate the building substantially as it was before the fire but with appropriate economies in the use of materials. I am fortified in this conclusion by the fact that throughout the considerable correspondence and negotiations which preceded this action…every one on the defendants’ side appears to have been ready to accept that, so long as the plaintiffs intended, to reinstate, the true measure of indemnity was the cost of reinstatement. No one suggested that this was a mark of eccentricity; it appears to have been accepted that it was not an unreasonable course to pursue. On the basis of reinstatement therefore I consider that the plaintiffs are entitled to £246,883, the figure produced by Haymills [building contractors instructed by the insurers’ adjusters]. This figure, however, takes no architects’ fees or VAT at 8 per cent. and architects’ and surveyors’ fees 12½ per cent. should therefore be added to that figure… It follows that I am not satisfied that the indemnity required would be any more than the £55,000 necessary to buy and erect a suitable building of modern steel, and asbestos construction and the land on which to erect it… Two points however, remain. The first is betterment. Now the principle of betterment t is too well established in the law of insurance to be departed from at this stage even though it may sometimes work hardship on the assured. It is simply that an allowance must be made because the assured is getting something new for something old. But in this class of insurance there is no automatic or accepted

percentage deduction. In some of the calculations put before me an attempt was made to establish a figure of 13.3 per cent as the appropriate reduction for betterment. This figure has no validity. It happens to be, mathematically, the result of stating as a percentage the figure agreed as a deduction for betterment between assessors and adjusters…But this deduction itself was clearly not the result of applying a percentage, and particularly not one as unlikely as 13.3 per cent. The figure was one which, when deducted from the adjusted Haymills’ figure left a convenient round sum. I have had no acceptable evidence on what would be the proper deduction for betterment on the basis that Haymills…is the estimate to be adopted, and I must do the best I can in the circumstances. When I consider that this estimate already takes into account the reuse of a great deal of second-hand material and, where it does not; accepts in many cases the substitution of inferior substances I think that betterment must very largely have been absorbed in the reduced estimate. There may well be some instances in which some new for old exchange can be detected, but they must be minimal and in any event the defendants have not adduced any satisfactory evidence which could enable me to make any confident further reduction, if reinstatement costs are to be taken. If the alternative of market-value is to be adopted, betterment must be applied to this. The hypothesis on which this value falls to be chosen is severely commercial so that betterment has considerable logical validity. Taking a broad view on the evidence I have heard, the figure for deduction probably lies between a third and a quarter of the total. On building costs of £35,000, a deduction of £10,000 would I think be fair to both sides. The total figure, including land, would then be £45,000.’

[1305] Leppard v Excess Insurance Co Ltd [1979] 1 WLR 512 (CA) [In 1972 the claimant purchased a cottage from his father-in-law as an investment for £1,500.00. He did not intend to live in it but proposed to sell it on at a profit. He insured the cottage against fire for £10,000. The proposal form stated that the sum insured represented the “full value” of the property: “full value” was defined as “the amount which it would cost to replace the property in its existing form should it be totally destroyed.” Upon renewal of the policy, he increased the sum insured to £14,000. Before any sale took place the property was totally destroyed by fire in 1975. The claimant claimed the rebuilding cost, some £8,000. The insurer contested the claim, arguing that the claimant was entitled only to the market value of the property at the time of the fire. This was agreed at £3,000, ie the selling price less the value of the site. The trial judge awarded the claimant the full cost of reinstatement, some £8,694.00. The insurers appealed]. Megaw LJ: ‘Ever since the decision of this court in Castellain v Preston (1883) 11 QBD 380, the general principle has been beyond dispute. Indeed I think it was beyond dispute long before Castellain v Preston. The insured may recover his actual loss, subject, of course, to any provision in the policy as to the maximum amount recoverable. The insured may not recover more than his actual loss. As it was put by Brett LJ in Castellain v Preston…

“In order to give my opinion upon this case, I feel obliged to revert to the very foundation of every rule which has been promulgated and acted on by the courts with regard to insurance law. The very foundation, in my opinion, of every rule which has been applied to insurance law is this, namely, that the contract of insurance contained in a marine or fire policy is a contract of indemnity, and of indemnity only, and that this contract means that the assured, in case of a loss against which the policy has been made, shall be fully indemnified, but shall never be more than fully indemnified. That is the fundamental principle of insurance, and if ever a proposition is brought forward which is at variance with it, that is to say, which either will prevent the assured from obtaining a full indemnity, or which will give to the assured more than a full indemnity, that proposition must certainly be wrong.” …What the insurers have agreed to do is to indemnify the insured in respect of loss or damage caused by fire. The “full value” the cost of replacement. That defines the maximum amount recoverable under the policy. The amount recoverable cannot exceed the cost of replacement. But it does not say that that maximum is recoverable if it exceeds the actual loss. There is nothing in the wording of the policy, including the declaration which is incorporated therein, which expressly or by any legitimate inference provides that the loss which is to be indemnified is agreed to be, or is to be deemed to be, the cost of reinstatement, the “full value,” even though the cost of reinstatement is greater than the actual loss. The plaintiff is entitled to recover his real loss, his actual loss, not exceeding the cost of replacement. There remains the second question. Was the plaintiff’s actual loss the cost of the reinstatement of the cottage? Or was it, as the defendants contend, the market value of the property as it was at the time of the fire? The defendants do not rely upon any general principle in support of their

submission. They say, rightly in my judgment, that this is a question of fact, and that one must look at all the relevant facts of the particular case to ascertain the actual value of the loss at the relevant date. Of course, one is entitled to look to the future so as to bring in relevant factors which would have been foreseen at the relevant date as being likely to affect the value of the thing insured in one way or the other, if the loss of it had not occurred on that date. But on the evidence in this case, and the judge’s statement of the relevant facts in the passages from his judgment which I have read earlier, it is beyond dispute that the plaintiff himself, at the relevant date, wished to sell the house, and was ready and willing to sell it for £4,500 — indeed, on his own evidence, for less. [Counsel for the claimant] submits that he was not bound to sell it. Of course not. He might thereafter, if the loss had not occurred, have changed his mind. The value of the property might have increased or it might have decreased. But there is no getting away from the reality of the case: “It was” (I am quoting again from the judgment) “an empty cottage that he had for the purpose of sale.” The judge says: “I do not think that this man, the plaintiff, would be put in the same position as he was before this fire merely by being paid the sum of £3,000, the difference between the price that he was prepared to accept for the property at the time of its loss and its site value.” With very great respect, I am unable to see why not. If the plaintiff himself was ready and willing, as he plainly was, to sell the property for £4,500, or less, on 25 October 1978, just before the fire, how can it be said that that was not its actual value at that time: unless, indeed, some reason could be shown why the plaintiff himself should have made a mistake about, or underestimated, its real value. No basis is shown for any such suggestion. The amount of the loss

here, in my judgment, is shown by the facts to have been the figure agreed, hypothetically, on this basis, as £3,000…’

Note: It is settled law that a claim under a contract of insurance is tantamount to a claim for unliquidated damages for breach of contract (The Fanti and The Padre Island [1991] 2 AC 1). It is also settled that no claim for damages will lie for a failure to pay damages (President of India v Lips Maritime Corporation [1998] AC 395). In the context of insurance law the combination of these two principles can have dire financial consequences for the insured. [1306] Sprung v Royal Insurance (UK) Ltd [1999] 1 Lloyds Rep IR 111 (CA) [The claimant, S, was the proprietor of a small business which processed animal waste products. S had two policies with the defendant insurers, theft insurance and a policy which provided cover in relation to the plant against “[s]udden and unforeseen damage…which necessitates immediate repair of the plant before it can resume normal working.” In April 1986, a time when the business was in financial difficulty, vandals broke into S’s premises and destroyed his machinery. The business ceased trading six months later. The insurers wrongfully denied liability and it was not until nearly four years later that S finally received indemnification in respect of the machinery. The trial judge found that S’s claim should have been paid by October 1986. S

claimed £75,000 in damages for the consequential losses he suffered as a result of the delay]. Evans LJ: ‘In my judgment the position which arose when the defendants dealt with this matter in the way they did (that is to say, by denying liability, even on a ground which subsequently they have not sought to uphold) placed the plaintiff in a position where he was entitled and, indeed, bound to proceed as if he was uninsured. In other words, he could proceed to reinstate or repair the damaged property if he was so advised. If he decided to do so and then subsequently claimed against the defendants under the policy, it seems to me that the defendants would not then be in a position to allege by way of defence that there had been a breach of condition (6) [of the policy]; in other words, they would have disqualified themselves from saying that, the repairs having been carried out without their consent, the plaintiff was not entitled to recover the promised indemnity under the policy. The question which arises is whether the plaintiff nevertheless can claim substantial damages from the defendants for their refusal to accept liability at that stage or for failing to say, “Go ahead if you wish to do so and are so advised.” In my judgment it is impossible to say that any such breach, even if and to the extent that it was a breach of contract, would carry with it a right to substantial damages representing the claim which is now put forward. What has to be said, however hard it may seem to say it, is that in such circumstances the cause of any loss which the plaintiff suffered must be regarded as the consequence of his own decision not to proceed with repair or reinstatement, whether that decision was voluntary or not. In other words, if, unfortunately, through his own financial circumstances he is unable to do so without assistance from

the defendants, he cannot allege that the defendants were in breach of contract by failing to accept liability at that stage. The other matter which I should mention in this connection is that the plaintiff has frankly acknowledged, in response to questions by my Lord, Lord Justice Beldam, that if the defendants had given a qualified reply in terms such as, “We give our consent but without any admission of liability,” then it is doubtful whether he would have been able to raise the necessary finance in any event. To go further than that would require placing on the defendants an obligation not merely to give their consent to repairs but to admit liability at that early stage, and in my judgment… that cannot be said against them. The first question, strictly, is whether the plaintiff should be permitted to raise this further issue now at this late stage. I for myself would be reluctant to hold that he should not do so if there was any reasonable prospect that the claim would succeed in the circumstances of the present case. I say that because, as the extracts from his evidence made clear, he made determined efforts in the course of his evidence to say that this was the very point which he wished to have decided. I would also be reluctant for the simple reason that I do not find the defendants’ submissions at all attractive, either from a commercial or from a moral point of view. They claim the right as insurers, in a policy in these terms which contemplate a degree of immediacy, to stand aside and to deny liability on grounds which subsequently are not maintained, whilst their insured continues in such financial difficulties that he has soon to cease carrying on business altogether. Apart from those more general considerations, there remains the aspect to which I have already referred, which is that the question does arise whether there is a reasonable prospect in the present case of the plaintiff recovering the damages which he seeks as a matter of law in the unusual

circumstances of the present case. With undisguised reluctance, I would hold that the law was correctly stated by the learned judge and that, even if the claim was reformulated in some such way as I have stated, there would be no measurable prospects of success in the circumstances of the present case. For those reasons I would dismiss this appeal.’

Beldam LJ: ‘…The insurers did not make a payment under the policy in respect of the plant and equipment the subject of the claim until some three and a half years later. The plaintiff pursued his claim for the loss caused by the insurers’ refusal to indemnify him and to pay him his loss or damage, which the judge was later to assess at the sum of £75,000. The insurers argued that they were not liable to their assured for damages for failure to meet their obligations under the policy. By long-standing decisions it is settled that the liability of insurers under a policy arises when the loss occurs and the liability is to pay money for that loss. That the insurers have the option themselves to reinstate or to pay for the reinstatement of the property damaged under the terms of the policy does not alter the essential nature of their liability, which is to pay the sum of money as damages. Thus the failure to pay is a failure to pay damages and, by decisions binding on this court, an assured has no cause of action for damages for non-payment of damages. To compensate a plaintiff in such circumstances Parliament has provided that the court should be able to award interest on the damages which the court eventually assesses. There will be many who share Mr Sprung’s view that in cases such as this such an award is inadequate to compensate him or any other assured who may have had to abandon his business as a result of insurers’ failure to pay, and that early consideration should be given to reform of the law in similar cases. It may be, although it was not

argued in this case, that an exception might be established where a policy is entered into whose whole purpose is to provide for the immediate repair of damaged plant and equipment. However, I find it difficult to distinguish between breach of a term of the policy which required expedition on the insurers’ part to inspect or give consent to the repairs and a requirement that they should meet their obligations under the policy promptly. I agree with my Lord, Lord Justice Evans, that, if the assured carried out his repairs after refusal by the insurers to meet the claim or after unreasonable delay on the insurers’ part, they could not contend that they were not liable because of breach by the assured of the conditions of the policy to which reference has been made. For the reasons which my Lord has given I too agree, with reluctance, that this appeal fails.’

Note: For comment see J Birds, [1997] JBL 368 who, echoing the sentiment expressed by the Court of Appeal, agrees that there should be a remedy in damages where the insurer, without reasonable grounds, repudiates or refuses to admit liability. He concludes by noting that the only solution may well lie with statutory reform. [1307] N Campbell, “The Nature of an Insurer’s Obligation” [2000] LMCLQ 42 [Footnotes in the original have been omitted]. ‘1. INTRODUCTION What is it that an insurer promises to do for an insured? The insured’s answer might be “Pay me money, or repair my

property, if I suffer a loss”. The courts of most common law jurisdictions provide a similar answer. However, the English courts would have it that an insurer promises to prevent loss or damage from occurring: to prevent car thefts, to prevent house fires, and to prevent ships from sinking. In this paper I examine the nature of an insurer’s obligation, and argue that the English courts are, for the most part, wrong… 3. INDEMNITY INSURANCE (a) Overview In this Part I examine the nature of an insurer’s obligation under a contract of indemnity insurance. My concern is with the obligation of an insurer who has promised in general terms “to indemnify” or “to insure” the insured against loss of or damage to property, or against legal liability. In relation to property insurance, recent English cases have treated the insurer’s obligation to indemnify as being a primary obligation to prevent the insured from suffering loss, and have held that the insurer is in breach of this primary obligation at the moment that insured property is lost or damaged. On this view, no notice of loss to the insurer, nor claim by the insured for payment, is necessary for the insurer to be in breach of contract. According to the English cases breach of this primary obligation gives rise to a secondary obligation to pay damages to the insured, and the payment of a claim by the insurer is simply the discharge of this secondary damages obligation. The English view of a property insurer’s obligation has important consequences for the remedies available to an insured when a property insurer fails to pay a claim. In summary, the consequences are: 1. Even if the insured has suffered foreseeable losses as a result of the insurer’s failure to pay claim (eg, profits lost as a result of the insured’s inability to pay for the replacement of damaged plant), the insured cannot

recover consequential damages from the insurer [The Italia Express (No 2) [1992] 2 Lloyd’s Rep 281; Sprung v Royal Insurance (UK) Ltd [1999] Lloyd’s Rep IR 111]. The rationale for this is that the insurer’s obligation to pay a claim arises as a secondary obligation to pay damages, and “there is no such thing as a cause of action in damages for late payment of damages” [President of India v Lips Maritime Corp (The Lips) [1988] AC 395, 425 per Lord Brandon of Oakbrook]. 2. Even if an insured could recover consequential damages, a “sum insured” provision in a contract of insurance limits the insurer’s secondary obligation to pay damages (including consequential damages), not merely the insurer’s primary obligation to indemnify. 3. The limitation period for an action by the insured begins to run from the time of the loss of or damage to the property, since this is the time at which the insurer is in breach of contract. In my view the recent English cases have, in relation to property insurance, adopted a peculiar meaning of “indemnify” and thereby misconceived the nature of the property insurer’s obligation. In the rest of this Part I argue that the English cases are based on flawed reasoning and poor use of precedent, and that they do not reflect the intentions of the parties to property insurance contracts. (b) The meanings of “to indemnify” and the English cases A promise “to indemnify” against loss could have one of three meanings: 1. A promise to prevent loss from occurring. 2. A promise that loss will not occur. 3. A promise to compensate the insured in the event that loss does occur. The parties to a contract of indemnity insurance are free to choose any of these three meanings as the basis for the insurer’s obligation. In the following sections I argue that, as

far as property insurance is concerned, the third meaning, indemnity as compensation for loss, is most likely to accord with the parties’ intentions. It is also the meaning that is most consistent with common policy obligations, with the insurer’s ability to perform the contract, and with precedent. On the other hand, with most contracts of liability insurance, the first meaning, indemnity as prevention of loss, most accurately reflects both the parties’ intentions and precedent. The recent English cases, which were concerned with property insurance, have gone astray by focusing on the first meaning of indemnify, when they should have been focusing on the third. This has been partly due to reliance on a statement of Lord Goff of Chieveley in The Fanti [above], a case concerned with the obligations of a P.&I. insurer under that part of the policy which covered the insured against legal liability. The policy contained a “pay to be paid” clause (a clause which stipulates that the insurer’s obligation to pay the insured, is conditional on the insured ‘having paid the third party). After incurring legal liability to a third party, but before paying the third party, the insured was wound up insolvent. The House of Lords had to determine what rights were transferred to the third party, on the insured’s winding-up, by the Third Parties (Rights against Insurers) Act 1930. The House of Lords held that the “pay to be paid clause made prior payment by the insured to the third party a condition precedent to the insurer’s obligation to pay the insured. In so doing their Lordships rejected the third party’s argument that such a condition of prior payment was implicit at common law, and that equity was always prepared to overcome the condition, even when it was expressed in the policy. In an important passage Lord Goff said:

“…I am unable to accept [counsel for the third party’s] submission that a condition of prior payment is, at common law, implicit in a contract of indemnity. I accept that, at common law, a contract of indemnity gives rise to an action for unliquidated damages, arising from the failure of the indemnifier to prevent the indemnified person from suffering damage, for example, by having to pay a third party. I also accept that, at common law, the cause of action does not (unless the contract provides otherwise) arise until the indemnified person can show actual loss: see Collinge v Heywood (1839) 9 Ad. & E. 633. This is, as I understand it, because a promise of indemnity is simply a promise to hold the indemnified person harmless against a specified loss or expense. On this basis, no debt can arise before the loss is suffered or the expense incurred; however, once the loss is suffered or the expense incurred, the indemnifier is in breach of contract for having failed to hold the indemnified person harmless against the relevant loss or expense.” Lord Goff s statement was relied on by Hirst J in The Italia Express (No 2), in which the insured claimed for a total loss of a ship under an agreed value policy. The insurers did not admit liability or pay the insured until the 37th day of the trial of proceedings brought by the insured, having up to that time run a defence that the insured procured the sinking of his ship. The insured, having endured eight days of cross examination, was not fully satisfied with receiving the agreed value, and pursued a claim for damages for other losses consequent upon the insurers’ late payment. Hirst J had to decide whether, assuming that such losses were not too remote, they were recoverable as matter of law. Both parties accepted, in view of Lord Goff’s statement in The Fanti, that under a contract of indemnity insurance the insurer agrees “to hold the insured harmless against loss or damage from the peril insured against”. However, the

parties differed as to what the obligation to “hold harmless” involved. The insured argued that the insurer’s primary obligation was to hold the insured harmless by paying compensation, so that a secondary obligation to pay damages arose if payment were not made on time. By contrast, the insurers’ argument was that: “…the agreement of the underwriters. under this policy of insurance to hold the assured harmless, constituted an obligation to prevent the assured from suffering loss from a peril insured against and was broken the moment the assured suffered loss from the peril insured against (i.e. in this case the sinking), since at that very juncture the underwriter had failed to prevent such loss.” The insurers further argued that the Marine Insurance Act 1906, s. 67 acted as a liquidated damages provision, so that the insurers’ obligation to pay damages was limited to the agreed value of the hull. Section 67(1) provides that: “The sum which the assured can recover in respect of a loss on a policy by which he is insured…in the case of a valued policy, to the full extent of the value fixed by the policy is called the measure of indemnity.” Hirst J accepted both arguments of the insurers. He held that on the loss of the ship the insurers breached their contract and came under a secondary obligation to pay damages to the insured. This secondary obligation was, pursuant to section 67, limited by the agreed value clause in the policy. Although the strict ratio of this case is that the Marine Insurance Act 1906, section 67 limited the insurers’ liability, Hirst J made it clear that he thought that the result would be the same in non-marine insurance cases. In his view a property insurer’s primary obligation was to prevent loss

from occurring, so that once loss occurred the insurer came under a secondary obligation to pay damages to the insured. He therefore characterised the insured’s claim in the case before him as “in essence one for damages for the late payment of damages”. Relying on President of India v Lips Maritime Corp. (The Lips), Hirst J said that the law did not recognise a cause of action in damages for the late payment of damages. Hirst J declined to follow Grant v CoOperative Insurance Soc Ltd [(21 October 1983); 134 NLJ 81] in which Hodgson J had awarded consequential damages to an insured for a fire insurer’s refusal to pay a claim. The Italia Express (No 2) was followed in a non-marine insurance setting in Sprung v Royal Insurance (UK) Ltd…The judgments in Sprung do not explicitly describe a property insurer’s obligation as being to prevent loss from occurring. That conception of the insurer’s obligation is, however, implicit in two aspects of the judgments: the reliance on The Italia Express (No 2), and the acceptance that the insurer is, on the occurrence of loss, immediately liable in damages to the insured. The same or a similar conception of a property insurer’s obligation has been accepted in other recent English cases. A retreat from this position appeared possible when the Court of Appeal recently granted leave to appeal the striking out of an insured’s claim for consequential darnages [Pride Valley Foods Ltd v Independent Insurance Co Ltd [1999] Lloyd’s Rep IR 120]. The master and judge below had struck out the claim following cases such as The Italia Express (No 2) and Sprung, but the Court of Appeal noted that those decisions had been criticized and were contrary to Commonwealth authorities. Leave was granted so that consideration could be given “as to whether the point was worthy of consideration by the House of Lords”. Subsequently, however, the insured’s underlying claim for indemnity has failed, so that the claim for damages has not further been explored.

The conception of a property insurer’s obligation expressed in these recent cases is a surprising one. In my view there are five distinct problems with the cases. First, the cases rely on the non-sequitur that, since an insured’s monetary remedy against a property insurer is in damages, a property insurer’s obligation must, from the time of loss, be one to pay damages. Secondly, the cases are suspect in terms of precedent. They misapply Lord Goffs statements in The Fanti, are inconsistent with other authoritative statements concerning the nature of a property insurer’s obligation, and are inconsistent with the conception of a property insurer’s obligation that is found in other common law jurisdictions. Thirdly, the cases adopt a meaning of indemnity that is most unlikely to accord with the intentions of the parties to a contract of property insurance. Fourthly, the cases cannot be satisfactorily reconciled with the contractual option commonly given to property insurers to discharge their obligations by reinstatement rather than by payment of money. Finally, even the narrow ratio of The Italia Express (No 2), based on the Marine Insurance Act 1906, cannot be supported… (f) Discharge of the property insurer’s obligation by reinstatement The English conception of indemnity views a property insurer’s payment of a claim as being the discharge of a secondary damages obligation. This view is difficult to reconcile with the contractual option commonly given to a property insurer to reinstate damaged or lost property, rather than pay a sum of money. Beldam, LJ, referred to this matter in Sprung as follows: “the liability of insurers under a policy arises when the loss occurs and the liability is to pay money for that loss. That the insurers have the option themselves to reinstate or to pay for the reinstatement of the properly…does not alter the

essential nature of their liability, which is to pay the sum of money as damages.” …I suggest that the proper way to regard the reinstatement option commonly given to property insurers is that it gives them an election between alternative modes of performing their primary obligation to indemnify. The two choices are alternative ways of indemnifying the insured by compensation. This accords with case law on reinstatement, and reflects” the likely intentions of the parties… 4. CONTINGENCY INSURANCE An examination of the nature of an insurer’s obligation is an easier matter for contingency insurance than for indemnity insurance. A contingency insurer promises to provide a benefit to the insured on the happening of certain insured events, usually death or personal accident. The benefit is agreed upon in advance (either fixed or by a formula) and bears no necessary relation to the loss that the insured suffers as a result of the insured event. A contingency insurer’s primary obligation is to pay the agreed benefit should an insured event occur. Unlike indemnity insurance, there has never been any suggestion that a contingency insurer promises to prevent the insured event from occurring. A contingency insurer does not promise. to “indemnify”, so there is no room for importing a concept of indemnity as prevention. It has been said that an insured under a contingency policy may sue a non-paying insurer in debt. This is true when the insured’s claim is liquidated, as it often is under a contingency policy. However, the insured’s claim may sometimes be unliquidated, as where the quantum of the claim depends on the extent of the insured’s injury, or on the level of the insured’s pre-injury income. In any case, should the insurer fail to pay the claim, the insured is additionally able to claim damages for the non-payment of a

debt. This is a matter that has not specifically been addressed in the insurance context in Engand, but it is now accepted that damages can be recovered under the second limb of Hadley v Baxendale [(1854) 9 Exch 341] for the failure to pay money, and this rule should apply to a failure to pay money under an insurance contract. 5. CONSEQUENCES FOR AN INSURED’S REMEDIES Here I examine some of the consequences of my arguments, assuming them to be correct, for the remedies that are available to an insured. (a) Damages for consequential losses An insured’s cause of action for damages against an insurer is a complaint that the insurer has failed to provide the promised benefit to the insured. There are two distinct types of losses for which the insured might seek damages. First, the insured will suffer a direct loss of the benefit that the insurer failed to provide. This direct loss will be quantified, in most cases, by determining the sum of money that the insurer was obliged to pay to or for the benefit of the insured, and, in some cases, by determining the value of a service (such as reinstatement) that the insurer was obliged to provide. Secondly, the insured might suffer other losses as a consequence of not receiving the benefit promised by the insurer. Such consequential losses can arise in the context of any type of insurance. With property insurance, for example, an insurer’s failure to pay a claim for damaged plant may mean that the insured is unable to repair the plant, and consequently loses production and profits. With liability insurance, the insurer’s failure to indemnify is likely to mean that the insured has to discharge a liability to a third party out of his or her own funds. The insured is likely to incur financing costs in so doing (even if only lost opportunity costs). With contingency insurance, the insurer’s failure to

pay money to the insured also may cause the insured to incur financing costs. As has been seen, the English courts have, in the case of property insurance, refused to award damages for consequential losses. The courts’ rationale is doctrinal: that a property insurer’s obligation to pay a claim arises as a secondary obligation to pay damages, and that damages cannot be awarded for the late payment of damages. The better view, I have argued, is that a property insurer’s obligation to pay a claim is a primary obligation, so that, a claim by an insured for consequential losses is a claim for damages for breach of a primary obligation. The English courts have not considered whether damages for consequential losses can be awarded, against a. liability insurer or against a contingency insurer. This is not surprising, given that it would be rare for an insured under a liability or a contingency policy to suffer consequential losses other than financing costs. The insured is likely to seek redress for such financing costs merely by claiming interest under the Supreme Court Act, 1981 section 35A(1) rather than claiming them as a separate head of damages. There are, however, occasions where the insured cannot recover interest (such as where the insurer pays late, but prior to the issue of proceedings), when the insured may want to rely on a separate damages claim. On the conception that I have proposed of the obligations of liability insurers and contingency insurers, there is no doctrinal reason why damages for consequential losses should not be awarded. Such losses are consequential upon the insurer’s failure to perform a primary obligation, not merely upon a failure to pay damages. For any type of insurance, therefore, damages for consequential losses should be recoverable on ordinary contractual principles of causation, remoteness and mitigation. Damages are recoverable by insureds on this

basis in New Zealand, Australia, and most jurisdictions of the United States. As a counter to my argument, it may fairly be pointed out that insureds in England have not, until recent years, sought to claim damages from insurers for consequential losses. This might suggest a nearly universal acceptance that insurers are not liable for consequential losses. In The Italia Express (No 2) Hirst J thought that the absence of previous claims reinforced his conclusion that insurers were not liable for such losses. The absence of previous claims is explicable on a basis that does not reinforce Hirst J’s conclusion [in the The Italia Express (No 2) [1992] 2 Lloyd’s Rep 281]. An insurer’s breach of contract consists, in almost every case, of a failure to pay money to the insured. The likely reason for the absence of previous claims for consequential losses is that, until recently, English courts were reluctant to award damages for the failure to pay, or late payment of, money. It is this reluctance to award damages (since removed by decisions such as Wadsworth v Lyall [[1981] 1 WLR 598]) that would have dissuaded insureds from seeking damages for losses caused by the insurer’s failure to pay money to the insured…’

Notes: 1. The problem that confronted the court in Sprung would receive a different judicial response in most US jurisdictions where it is recognised that insurance contracts carry an implied term of good faith and fair dealing which requires both the insurer and the insured to conduct themselves in a way so as not to prejudice the right of the other to receive the benefit of the contract. It has been commented that, “The

insurers’ obligations are…rooted in their status as purveyors of a vital service…The obligations of good faith and fair dealing encompass qualities of decency and humanity inherent in the responsibilities of a fiduciary. Insurers hold themselves out as fiduciaries and with the public’s trust must go private responsibility consonant with that trust.” (Goodman and Seaton, “Foreword: Ripe for Decision, Internal Workings and Current Concerns of the California Supreme Court” [1974] Cal L Rev 309, at 346–47. 2. The classic statement of the doctrine was delivered by the Supreme Court of New Jersey in Bowler v Fidelity and Casualty Company of New York 250 A 2d 580 (1969): ‘Insurance policies are contracts of utmost good faith and must be administered and performed as such by the insurer…In all insurance contracts, particularly where the language expressing the extent of the coverage may be deceptive to the ordinary layman, there is an implied covenant of good faith and fair dealing that the insurer will not do anything to injure the right of its policyholder to receive the benefits of his contract.’

3. Thus, in US jurisdictions an insurer therefore has the duty to act in good faith. Breach of this duty may give rise to a bad faith action in tort against the insurer and where the breach is accompanied by wrongful or malicious conduct, an action for punitive damages may lie. (see also Whiten v Pilot Insurance Co [2002] 1SCR 595, Supreme Court of Canada).

[1308] Egan v Mutual of Omaha Insurance Company 24 Cal 3d 809 [The facts appear from the judgment]. Mosk J: ‘Defendants appeal from a judgment awarding compensatory and punitive damages for breach of an insurance contract. We conclude the judgment should be affirmed insofar as it awards compensatory damages against defendant Mutual of Omaha Insurance Company (Mutual) but reversed in all other respects… In 1962, plaintiff purchased a health and disability insurance policy from defendant Mutual through its Los Angeles representative…The policy provided for lifetime benefits of $200 per month in event the insured became totally disabled as a result of either an accidental injury “independent of sickness and other causes” or sickness sufficiently severe to cause confinement of the insured to his residence. Benefits for a nonconfining illness were payable for a period not to exceed three months. Between 1963 and 1970 plaintiff claimed and received payments for three separate back-related disabling injuries. In May 1970, he made a fourth claim for accidental back injury suffered during the course of his employment. Portions of the claim form were completed by both plaintiff and his physician. The physician estimated plaintiff would be able to return to work in August 1970. In September plaintiff visited the [insurer’s agent] and discussed his claim. This discussion resulted in payment under the policy’s accident provisions for a three-month period following date of injury. Plaintiff filed a supplemental claim in October 1970, stating he was unable to return to work. Because his physician indicated on the claim form that plaintiff could have returned to work on September 29, defendant

McEachen, an agency claims manager, reviewed workers’ compensation and State Compensation Insurance Fund medical records. These records disclosed that plaintiff and the examining physician had agreed he would return to work on 1 July 1970. On 20 November McEachen visited plaintiff at home. McEachen testified he merely discussed contradictions in the claim form and agreed to discuss the matter later after further investigation. Plaintiff testified that McEachen informed him no further benefits were due because he was not actually disabled but simply unable to find work, that he told McEachen employment was available through his labour union but because he still suffered from his injury he was unable to accept such employment, and that he was willing to be examined by any doctor of Mutual’s choice. In February 1971, as a result of inquiry from Mutual’s home office, McEachen addressed a letter to plaintiff enclosing payment of benefits through 29 September 1970. The letter stated the cheque represented full payment of benefits due under the policy. On 26 February 1971, surgery was performed on plaintiffs back, and he submitted another claim to the agency. The physician’s portion of this claim form included an estimate by the surgeon that plaintiff could return to work “Possibly 3–6 months from date of surgery.” This claim was assigned to defendant Segal, an agency claims adjuster, who was aided in his field investigations by claims analyst Romano from Mutual’s home office. Although not entirely clear, it appears Romano was assigned to the agency to assist in a backlog of field investigations. Romano was not Segal’s superior, rather, he occupied a position equivalent to that of Segal. in the agency. Segal and Romano, in the course of their field investigations, reviewed records of Workers’ Compensation Appeals Board, State Compensation Insurance Fund, and the hospital where plaintiff’s surgery was performed. State

Compensation Insurance Fund records contained letters from Dr Carpenter, plaintiffs surgeon, and Dr Singelyn. Dr Carpenter wrote in his letter: “[Plaintiff’s medical] history appears consistent with a man with probable discogenic disease with multiple aggravations over the last several years, finally culminating in a specific incident a little over seven months ago….” Dr Singelyn declared in his letter: “I would apportion 50% of his current subjective complaints to his industrial injury, and 50% to the natural progression of his pre-existing pathology of degenerative wear and tear osteoarthritis of the spine.” Neither Segal nor Romano made any effort to contact plaintiff’s physicians. Trial testimony established that efforts to discuss the case with attending physicians would ordinarily have been made by a claims adjuster. Based on Segal’s review of medical records, plaintiff’s condition was reclassified from injury to nonconfining illness. In May 1971 Segal visited plaintiff at home, telling him he suffered from an illness, not an injury. Segal handed plaintiff a check for medical costs and three months’ maximum disability payments. Plaintiff did not cash the check. He testified he refused Segal’s offer for a larger check if plaintiff would surrender his policy. He further testified that after discussing the matter with Dr Carpenter, he wrote to Segal concerning his reclassification but received no answer. Segal testified he was certain he acted at the direction of some higher authority during the May 1971 meeting, although he could not recall who directed him. Mutual’s files contained no written directive to Segal. Gustin, head of Mutual’s continuing disability claims division, attempted to explain the absence of any identifiable person in authority at Mutual’s home office to receive and review Segal’s reports. He testified plaintiff’s file had not been in his department after December 1970, and that it may have “fallen…into a crack.”

Subsequently, plaintiff received a 73 per cent disability rating on his workers’ compensation claim. Not returning to work, he remained under medical care. In July 1972, at plaintiff s request, the Department of Insurance asked Mutual to review plaintiff’s file and report to the department within 15 days. The nature of Mutual’s response, if any, is unclear; it was not produced at trial. In 1973, plaintiff commenced the present action for compensatory and punitive damages against Mutual, Segal and McEachen. The trial court, in directing a verdict against defendants, ruled as a matter of law that defendants’ failure to have plaintiff examined by a doctor of their choice or to consult with plaintiffs treating physicians and surgeon violated the covenant of good faith and fair dealing. The court submitted to the jury the issues of causation, compensatory and punitive damages. The jury returned verdicts against all defendants. General damages of $500 and punitive damages of $400 were assessed against Segal. General damages of $1,000 and punitive damages of $500 were assessed against McEachen. Mutual was held liable for $45,600…in general damages, $78,000 for emotional distress, and $5 million in punitive damages. The directed verdict on the issue of breach of covenant of good faith and fair dealing rests on Mutual’s inadequate investigation of plaintiffs claim. Mutual argues that an insurer violates this covenant in a disability insurance contract only if it wrongfully denies a claim knowing it has no reasonable basis for doing so, and that the ruling herein improperly subjects it to strict liability in tort for breach of contract. We disagree. For the reasons discussed below, we conclude that an insurer may breach the covenant of good faith and fair dealing when it fails to properly investigate its insured’s claim. In addition to the duties imposed on contracting parties by the express terms of their agreement, the law implies in every contract a covenant of good faith and fair dealing…

The implied promise requires each contracting party to refrain from doing anything to injure the right of the other to receive the benefits of the agreement…The precise nature and extent of the duty imposed by such an implied promise will depend on the contractual purposes. This court has previously addressed the extent of the duties imposed by the implied covenant in liability insurance policies. (Johansen v California State Auto Assn Inter-lns Bureau (1975) 15 Cal 3d 9 [123 Cal Rptr 288, 538 P 2d 744]; Crisci v Security Ins Co (1967) 66 Cal 2d 425; Comunale v Traders & General Ins Co (1958) 50 Cal 2d 654) We there held that the insurer, when determining whether to settle a claim, must give at least as much consideration to the welfare of its insured as it gives to its own interests. The governing standard is whether a prudent insurer would have accepted the settlement offer if it alone were to be liable for the entire judgment.…The standard is premised on the insurer’s obligation to protect the insured’s interests in defending the latter against claims by an injured third party. The implied covenant imposes obligations not only as to claims by a third party but also as to those by the insured. (Silberg v California Life Ins Co (1974) 11 Cal 3d 452 [113 Cal Rptr 711, 521 P 2d 1103]; Gruenbeng v Aetna Ins Co (1973) 9 Cal 3d 566 [108 Cal Rptr 480, 5 10 P2d 1032].) In both contexts the obligations of the insurer “are merely two different aspects of the same duty”(Gruenberg v Aetna Ins Co, above, at 573).…“[W]hen the insurer unreasonably and in bad faith withholds payment of the claim of its insured, it is subject to liability in tort.” (Gruenberg, at 575…). For the insurer to fulfill its obligation not to impair the right of the insured to receive the benefits of the agreement, it again must give at least as much consideration to the latter’s interests as it does to its own (Silberg, at 460). The insured in a contract like the one before us does not seek to obtain a commercial advantage by purchasing the policy — rather, he seeks protection against calamity. As

insurers are well aware, the major motivation for obtaining disability insurance is to provide funds during periods when the ordinary source of the insured’s income — his earnings — has stopped. The purchase of such insurance provides peace of mind and security in the event the insured is unable to work…To protect theseinterests it is essential that an insurer fully inquire into possible bases that might support the insured’s claim. Although we recognize that distinguishing fraudulent from legitimate claims may occasionally be difficult for insurers, especially in the context of disability policies, an insurer cannot reasonably and in good faith deny payments to its insured without thoroughly investigating the foundation for its denial. Here the evidence is undisputed that Mutual failed to properly investigate plaintiffs claim,; hence the trial court correctly instructed the jury that a breach of the implied covenant of good faith and fair dealing was established. II Civil Code section 3294 provides: “In an action for the breach of an obligation not arising from contract, where the defendant has been guilty of oppression, fraud, or malice, express or implied, the plaintiff in addition to the actual damages, may recover damages for the sake of example and by way of punishing the defendant…” In the present context the principal purpose of section 3294 is to deter acts deemed socially unacceptable and, consequently, to discourage the perpetuation of objectionable corporate policies…The special relationship between the insurer and the insured illustrates the public policy considerations that may support exemplary damages in cases such as this…[T]he relationship of insurer and insured is inherently unbalanced; the adhesive nature of

insurance contracts places the insurer in a superior bargaining position. The availability of punitive damages is thus compatible with recognition of insurers’ underlying public obligations and reflects an attempt to restore balance in the contractual relationship… [T]he propriety of punitive damages was also reviewed by the trial court when it rejected both defendants’ motion for new trial and their motion for judgment notwithstanding the verdict. A brief analysis of the record convinces us that substantial evidence supports the jury’s decision to assess punitive damages. Plaintiff received his first payment from Mutual on the claim in issue herein only after a long delay and a personal visit to the claims office. When he requested additional payments as a result of his continuing inability to work, McEachen visited him at his home. Testimony was introduced that McEachen, although aware of plaintiff’s good faith efforts to work, called plaintiff a fraud and told him that he sought benefits only because he did not want to return to work. McEachen advised plaintiff he was not entitled to any further payments and that past benefits received were also unwarranted, despite plaintiffs bona fide claim of accidental injury. When plaintiff expressed his concern regarding the need for money during the approaching Christmas season and offered to submit to examination by a physician of Mutual’s choice, McEachen only laughed, reducing plaintiff to tears in the presence of his wife and child. After plaintiff received what Mutual designated his “final” payment, he was compelled to undergo back surgery. Segal visited plaintiff after he made further requests for total disability payments because he was confined to his home for medical reasons. Segal told him that he was not incapacitated from an accidental injury but had a “sickness” that could not qualify under the policy’s total disability provision. Despite the lack of support for denying plaintiffs

disability claim, Segal offered a “final” cheque under the policy’s sickness provision, or a larger check if plaintiff would surrender the policy. Other evidence reflected both Segal’s and McEachen’s knowledge that plaintiff had a 12 year old child and a totally disabled wife. In short, the record as a whole contains substantial evidence from which the jury might reasonably find that defendant “acted maliciously, with an intent to oppress, and in conscious disregard of the rights of its insured.” (Neal v Farmers Ins Exchange (1978) 21 Cal 3d 910, 923 [148 Cal Rptr 389, 582 P 2d 980].) Mutual advances an alternate ground for reversal on the issue of punitive damages, that the actions of McEachen and Segal cannot be imputed to Mutual for this purpose. In a broad sense, it is correct to state that California follows the Restatement rule regarding assessment of punitive damages against a principal: “Punitive damages can properly be awarded against a master or other principal because of an act by an agent if, but only if, (a) the principal authorized the doing and the manner of the act, or (b) the agent was unfit and the principal was reckless in employing him., or (c) the agent was employed in a managerial capacity and was acting in the scope of employment, or (d) the principal or a managerial agent of the principal ratified or approved the act.’ (Rest 2d Torts (Tent. Draft No 19, 1973) 909) However, prior cases have not ascribed to the Restatement the narrow interpretation proposed by Mutual…. Mutual argues that neither McEachen nor Segal can be considered “managerial employees” because neither was involved in “high-level policy making. The determination whether employees act in a managerial capacity, however, does not necessarily hinge on their “level” in the corporate hierarchy. Rather, the critical inquiry is the degree of discretion the employees possess in making decisions that will ultimately determine corporate policy. When employees

dispose of insureds’ claims with little if any supervision, they possess sufficient discretion for the law to impute their actions concerning those claims to the corporation. We are satisfied that with respect to plaintiff’s claim herein, the authority vested in McEachen and Segal was sufficient to justify the imposition of punitive damages against Mutual. The record demonstrates they exercised broad discretion in the disposition of plaintiff’s claim. Moreover, McEachen’s own description of his responsibilities at Mutual reflect his exercise of policy-making authority as a “managerial employee.” He testified that his business card displayed to policyholders identified him as “Manager, Benefits Department Mutual of Omaha.” He further explained he was manager of the Los Angeles claims department for Mutual, and in that capacity had ultimate supervisory and decisional authority regarding the disposition of all claims, like that of plaintiff, processed through the Los Angeles office. Although Segal testified that he acted with directions from above, the record provides little support for this testimony; it appears, therefore, that with respect to plaintiff s claim he also possessed broad discretion. The authority exercised by McEachen and Segal necessarily results in the ad hoc formulation of policy…. III We turn to the question whether the amount of the punitive damage award herein — $5 million — is excessive as a matter of law. We have recently reviewed the considerations governing appellate determination of such questions, and need not reiterate them at this time [citations omitted]… Applying those considerations to the case at bar, we observe first that the award of punitive damages is more than 40 times larger than the not-insubstantial assessment of $123,600 in compensatory damages against Mutual. In addition, the punitive damage figure herein represents two

and one-half months of Mutual’s entire net income in 1973, and more than seven months of such income in 1974. Viewing the record as a whole and in the light most favorable to the judgments, we conclude that in these circumstances the punitive damage award against Mutual must be deemed the result of passion and prejudice on the part of the jurors and excessive as a matter of law. IV Segal and McEachen acted as Mutual’s agents. As such, they are not parties to the insurance contract and not subject to the implied covenant. Because the only ground for imposing liability on either Segal or McEachen is breach of that promise, the judgments against them as individuals cannot stand… The judgment against Segal and McEachen is reversed. The judgment against Mutual is affirmed as to the award of compensatory damages and reversed as to the award of punitive damages…’ Bird CJ, Tobriner J and Manuel J concurred. Clark J concurred but dissented in relation to to the finding that a punitive damage award is permissible in this action.

13.2 Reinstatement In property insurance the insurer may pay for the replacement or repair of the insured property instead of paying over the sum insured to the policyholder. Reinstatement is required by the Fires Prevention (Metropolis) Act 1774 following loss by fire. In other cases where the statute is not applicable, the insurer can require reinstatement only if the policy expressly

provides for it (hereafter termed contractual reinstatement). Reinstatement reinforces the requirement of insurable interest insofar as it seeks to address the moral hazard of insured persons succumbing to the temptation of bringing about the loss in order to collect insurance money.

13.2.1 Statutory Reinstatement The Fires Prevention (Metropolis) Act 1774 requires an insurance company to reinstate a building destroyed by fire at the request of any person having an interest in the building. The statute applies only to ‘houses or other buildings’ (section 83). Insurance on personal chattels such as the contents of a building is therefore outside the scope of the Act (Sinnot v Bowden [1912] 2 Ch 414). The statute has been held to be of ‘general and universal application’ and not restricted to London (see ex p Gorely (1864) 4 De G J & S 477, per Lord Westbury LC, where the insured property was located in Dover). However, it does not apply to Scotland (Westminster Fire Office v Glasgow Provident Investment Society (1888) 13 App Cas 699). Nor does it apply to members of Lloyd’s (Portavon Cinema Co Ltd v Price and Century Insurance Co Ltd [1939] 4 All ER 601), because section 83 restricts its application to ‘governors or directors of [fire] insurance offices’, ‘and the corporation of Lloyd’s do not insure anybody against anything’ (per Branson J).

[1309] Fires Prevention (Metropolis) Act 1774 (14 Geo 3, c 78) Section 83 Money Insured on Houses Burnt how to be Applied And in order to deter and hinder ill-minded persons from wilfully setting their house or houses or other buildings on fire with a view of gaining to themselves the insurance money, whereby the lives and fortunes of many families may be lost or endangered: it shall and may be lawful to and for the respective governors or directors of the several insurance offices for insuring houses or other buildings against loss by fire, and they are hereby authorised and required, upon the request of any person or persons interested in or intitled unto any house or houses or other buildings which may hereafter be burnt down, demolished or damaged by fire, or upon any grounds of suspicion that the owner or owners, occupier or occupiers, or other person or persons who shall have insured such house or houses or other buildings have been guilty of fraud, or of wilfully setting their house or houses or other buildings on fire, to cause the insurance money to be laid out and expended, as far as the same will go, towards rebuilding, reinstating or repairing such house or houses or other buildings so burnt down, demolished or damaged by fire, unless the party or patties claiming such insurance money shall, within sixty days next after his, her or their claim is adjusted, give a sufficient security to the governors or directors of the insurance office where such house or houses or other buildings are insured, that the same insurance money shall be laid out and expended as aforesaid, or unless the said insurance money shall be in that time settled and disposed of to and amongst all the contending parties, to the satisfaction and approbation of such governors or directors of such insurance office respectively.

Note: Although not a party to the insurance contract, any person with an interest in the destroyed building has a right under section 83 to direct the insurers to apply the insurance moneys (so far as they will go) towards reinstating or rebuilding the insured property which has been damaged or lost by fire. Such persons will generally have a legal or equitable interest: obvious examples include mortgagees and tenants (see Sinnot v Bowden [1912] 2 Ch 414). [1310] Lonsdale & Thompson Ltd v Black Arrow Group plc [1993] Ch 361 [Under the terms of a lease the landlords covenanted to insure the premises for their full reinstatement value and ‘in the case of destruction or damage to the demised premises by any insured risk…to ensure…that all moneys payable…be laid out and applied in…reinstating the premises.’ The landlords contracted to sell the freehold but before completion the premises were destroyed by fire. The sale nevertheless continued and the purchase price was paid in full to the landlords. The insurers refused to pay for the rebuilding of the premises on the basis that the policy, clause 13 of section A, provided for the indemnity of the landlords’ freehold interest. They agued that the landlords had parted with their interest from the date of the contract of sale and had, in any case, received indemnity having been paid the full price on completion. The tenant sought to rely on section 83 of the 1774 Act against the insurers. The

issue was whether the policy inured for the tenant’s benefit despite the sale]. Jonathan Sumption QC (sitting as a deputy High Court judge): ‘Under section 83 of the Fire Prevention (Metropolis) Act 1774 (14 Geo 3, c 78), the tenant was entitled to require the insurers to discharge such liability as they might have to their assured under the policy by reinstating the premises. A notice has been duly served on the insurers under the Act. But the insurers have declined to comply with it, on the ground that they do not have any contractual liability to their assured and cannot therefore have any statutory liability to the tenant. They say that they are not obliged to do more than indemnify the landlords in respect of injury to that freehold interest, because it is only in respect of that interest that they can have suffered any loss. The result of the contract of sale was that at the time of the fire the landlords had parted with their entire beneficial interest in the property, retaining no other interest than their vendor’s lien for the price. When, upon completion, they received the price in full without any abatement on account of the fire, they were completely indemnified for their loss. As for the landlords’ liability to lay out the insurance proceeds in reinstatement, that arises only if and when they are received. It follows, the insurers say, that nothing is payable by them. The question on this application is whether they are right. In my judgment they are not. The foundation of the insurer’s case is the decision of the Court of Appeal in Castellain v Preston (1883) 11 QBD 380. That case had some points in common with the present one. A vendor contracted to sell property, but the buildings on it were destroyed by fire between contract and completion. The vendor was insured and the insurers paid him the full amount of the damage before completion. The vendor then

received, upon completion, the full purchase price. It had been held in previous litigation between the vendor and the purchaser that the vendor was not accountable to the purchaser for the insurance proceeds, there being no provision to that effect in the contract of sale: Rayner v Preston (1881) 18 ChD. 1. In these circumstances the insurers sued the vendor as their assured for a sum corresponding to what they had paid him on account of the loss. The ground of their claim was not that they had never been liable under the policy. It was that the subsequent recovery of an undiminished purchase price had made good the assured’s loss. The question at issue was whether the insurers were subrogated to the right of the assured to receive an undiminished price under the contract of sale. The Court of Appeal held that they were, overruling Chitty J who had held that the claims to which the insurers were subrogated were confined to those connected with the circumstances of the loss. The ground of the Court of Appeal’s decision was that because property insurance was prima facie a contract of indemnity, the insurer’s right of subrogation must be extensive enough to ensure that no more than an indemnity was recovered. The insurer was therefore subrogated to every right of the assured whose exercise would diminish his loss. That included the right to receive the proceeds of his contract of sale without abatement for fire damage. Brett LJ delivered the leading judgment. He said, at p 390: “there was a right in the defendants to have the contract of sale fulfilled by the purchasers notwithstanding the loss, and it was fulfilled. The assured have had the advantage therefore of that right, and by that right, not by a gift which the purchasers could have declined to make, the assured have recovered, notwithstanding the loss, from the purchasers, the very sum of money which they were to obtain whether this building was burnt or not. In that sense I

cannot conceive that a right, by virtue of which the assured has his loss diminished, is not a right which, as has been said, affects the loss. This right…affects the loss by enabling the assured, the vendors, to get the same money which they would have got if the loss had not happened.” … Bowen LJ said, at pp 401–402: “What is really the interest of the vendors, the assured?… Their interest…is that at law they are the legal owners, but their beneficial interest is that of vendors with a lien for the unpaid purchase-money; they would get ultimately all the purchase-money provided the matter did not go off owing to defective title. Such persons in the first instance can obviously recover from the insurance company the entire amount of the purchase-money…but can they keep the whole, having lost only half? Surely it would be monstrous to say that they could keep the whole, having lost only half… They would be getting a windfall by the fire, their contract of insurance would not be a contract against loss, it would be a speculation for gain. Then what is the principle which must be applied? It is a corollary of the great law of indemnity, and is to the following effect: — That a person who wishes to recover for and is paid by the insurers as for a total loss, cannot take with both hands. If he has a means of diminishing the loss, the result of the use of those means belongs to the underwriters. If he does diminish the loss, he must account for the diminution to the underwriters.” The problem about the submission which Mr Hart, on behalf of the insurers, seeks to base on this decision is that it elides two distinct questions. The first is whether the vendor’s recovery from the insurer is confined to the loss which he has suffered in respect of his own limited interest

in the property at the time of the fire. This question is directed to determining what the vendor’s initial loss is and what, therefore, would be payable to the vendor if the claim were adjusted and settled immediately after the fire and before completion. The second question is the one with which Castellain v Preston… was concerned, namely whether the subsequent receipt by the vendor of the full purchase price agreed before the fire goes to diminish that loss. The starting point in considering the first question is that the landlords unquestionably had an insurable interest in the premises up to the full reinstatement cost. I am inclined to think that it would be enough to give them that interest that they were liable to lay out the insurance proceeds on reinstatement, even though that liability would arise only after they had received them. The whole law as to what amounts to an insurable interest and when it is required, is derived from the statutory avoidance of wagering contracts, and it is hard to see how an assured who was obliged to spend the proceeds on reinstatement could be said to wager on the occurrence of a fire…The landlords owed an obligation under the lease to insure for the full reinstatement value. They therefore had an insurable interest up to that value because if they did not insure and the premises were damaged, they would be liable to the tenant. The full reinstatement value of the premises, which ought on that footing to have been recoverable from the insurer, would be the measure of their liability… The question whether the measure of the insurer’s liability is limited to the injury done to the landlords’ reversion therefore depends not on any overriding principle of law but on the terms of the policy. Insurances on property are prima facie to be construed as contracts of indemnity. Subject to the express terms of the policy the measure of the indemnity is the diminution in the value of the thing insured as a result of the operation of the insured peril. The parties

may agree that the damage suffered by the thing insured will be assessed on some agreed basis. There may, for example, be an agreed undamaged value. There may be a provision, such as the one found in this case, that the cost of reinstatement, which would otherwise be no more than evidence of the diminution in value of the property, shall be the measure of the insurer’s liability. But provisions such as these do not prevent the contract from being one of indemnity. They merely require the value of the indemnity to be calculated on conventional facts. It remains necessary to look at the particular position of the assured to see whether in the circumstances he would, by recovering the contractual measure, obtain more than an indemnity. If the assured has only a limited interest in the property, being, for example, a tenant or reversioner, a trustee, a mortgagee or a bailee, the value of his own interest may have diminished by much less than the value of the property or the cost of its reinstatement. But it does not necessarily follow that if the assured recovers the whole diminution in the value of the property or the whole cost of reinstatement he will be getting more than an indemnity. That must depend on what his legal obligations are as to the use of the insurance proceeds when he has got them. If he is accountable for the proceeds to the owners of the other interests, then he will not be receiving more than an indemnity if the insurer pays the full amount for which the property was insured. This will be so, whether the assured is accountable to the owners of the other interests as a trustee of the proceeds of the insurance or simply on the basis that he owes them a contractual obligation to pay those proceeds over to them or to employ them in reinstatement. None of this means that a party with a limited interest who insures the entire interest in the property is insuring on behalf of the others as well as for himself. All that it means is that his obligations as to the use of the insurance moneys once they have been paid are relevant in determining

whether he will recover more than an indemnity by getting the measure of loss provided for in that policy. The clearest illustration of the operation of these principles is the case of a trustee. There has never been any doubt that a trustee may insure the whole beneficial interest in property of which he holds only the legal estate, and that he may recover from the insurers the entire diminution of its value notwithstanding that the beneficial owners were not co-assureds. The reason is not that a trustee is personally liable to beneficiaries for damage done by insurable risks irrespective of whether he has received the insurance proceeds, for he will usually not be. The reason must be that he is accountable to the beneficiaries for such insurance proceeds as he may receive. Being accountable to them on that basis, the payment to him of those proceeds cannot give him more than an indemnity even though they exceed the value of his personal interest. That this is the correct analysis of the position is demonstrated by a series of decisions about insurances effected by bailees on property belonging to their bailors [the judge considered Waters v Monarch Fire and Life Assurance Co and A Tomlinson (Hauliers) Ltd v Hepburn, see chapter 6]… It is true that a bailee has a rather special status in English law, having in many respects the rights of an owner as against third parties. But the decisions in the Waters,… and Tomlinson cases do not turn on any principle peculiar to the law of bailment. Similar principles apply to insurance in quite different fields. I have already given trustees as one example. Another is the case of a trade union which insures the property of its members against burglary. It may recover the value of the stolen property, accounting for it to its members: Prudential Staff Union v Hall [see chapter 6]… The authors of these judgments regarded them as turning on two critical factors. The first was that in each case the subject matter of the insurance was the whole interest in

the property insured and not simply the assured’s interest. That was treated as a question of construction: see, in particular, Lord Reid in Tomlinson… It is usually enough that when construed on ordinary principles the policy covers the whole value of the subject matter and not only the value of some partial interest in it. The second factor was that so far as the assured was thereby enabled to recover in excess of the value of his own interest, it had to be shown that he would be accountable for that excess, either by virtue of his own distinct legal obligations to the holders of the other interests or by virtue of a trust which the courts were, at least in some cases, prepared to construct for the occasion. Both of these are features of the present case. By virtue of clause 13 of section A of the policy the subject matter of the insurance is damage to the premises up to their full reinstatement value, and not simply that proportion of it which may relate to the landlords’ reversion. Although the landlords have no general obligation under the lease to reinstate the premises after a fire irrespective of receipt of the insurance proceeds, it is expressly provided that upon receipt of insurance proceeds they have an obligation to lay them out in reinstatement, for the benefit of the tenant. Once that point is reached, it can be seen that the decision of the Court of Appeal in Castellain v Preston… is irrelevant. In Castellain v Preston the only other person, apart from the assured, who had any interest in the property was the purchaser, and it had already been held that the assured was not accountable to him. It followed that the assured would be receiving more than an indemnity if he were allowed to keep the insurance proceeds without accounting to the insurer. In the present case the landlords are certainly no more accountable to the purchaser than Mr Preston was, but there is a tenant and the landlords are accountable to him. Moreover they continue to owe that obligation to the tenant for it cannot be affected either by

their contract to sell the freehold to a third party or by its conveyance to the purchaser in due course. Suppose that on the day after the fire the insurer had been required to meet his obligations to the landlords. Even if there had been no lease, it would have been no defence for the insurer at that stage to say that in due course the landlords would be entitled to receive an undiminished purchase price on completion. Without express agreement to that effect, a person who has contracted to indemnify another can never refuse on the ground that an indemnity can be obtained from someone else…If then the insurers duly paid the reinstatement cost to the assured before completion, as was done in Castellain v Preston, would they have been entitled by virtue of their subrogation rights to recover an equivalent amount out of the purchase price once it was paid six weeks later? Of course not. The reason is that the landlords, having received the insurance moneys, would have become liable to the tenant to lay them out in reinstatement of the premises. The subsequent receipt of the purchase price would not, in these circumstances, in the least diminish the loss.’

Note: The request to reinstate should expressly refer to the statute. However, where due notice has been delivered to the insurers but they fail to reinstate, the interested person cannot go ahead with the reinstatement and claim the costs from the insurers. Rather, the appropriate course of action is to apply for a mandatory injunction against the insurers compelling them to comply with section 83 (cf Wimbledon Golf Club v Imperial Insurance Co (1902)

18 TLR 815, in which it was suggested that the appropriate remedy was an injunction). [1311] Simpson v Scottish Union Insurance Co (1863) 1 H & M 618 [The facts appear from the judgment]. Page-Wood V-C: ‘The questions raised in the argument on this demurrer are of considerable importance…The way in which the case is put, apparently in accordance with the facts, is this. It is averred that there was an agreement with the tenants that they should insure, and that they did insure in their own names; that when the fire had taken place the Plaintiff went to see the secretary of the insurance office, and claimed to be entitled to the benefit of the policy, and to have the amount applied towards rebuilding the houses, and said that he relied on the office paying nothing to the tenants; to which the secretary assented. There was no reference, on this occasion, to the statute; and it is certainly a very weak averment of a request to have the money applied under the terms of this Act of Parliament. It seems to amount to no more than a demand that the money should be paid to or for his benefit, and not to his tenants. But this conversation was followed by a formal notice on 31 December 1861; and that notice is simply a notice not to pay the tenants, the reference evidently being to the agreement to insure. That is not a request to the company such as the Act requires, but a claim to be entitled to have the policy money paid to him, or for his benefit, and not to the tenants. Nothing more took place before the company came to a settlement with the tenant, who abandoned the house policy on being paid the insurance on his goods. Then come averments of further communications with the secretary, in which the money is

claimed, and still no reference made to the statute. Throughout, the Plaintiff is not requesting the company to lay out the money in the manner prescribed by the Act of Parliament, but claiming to be the person really interested under the policy. Now, I apprehend that is not the case at which the enactment points (supposing it to be applicable without reference to locality). I agree that a tenant from year to year, having insured, would have a right to say that the premises should be rebuilt for him to occupy, and that his insurable interest is not limited to the value of his tenancy from year to year. Then the statute gives the landlord the right to require the money insured by his tenant’s policy to be laid out in rebuilding. But I think it is too clear for argument that, if the owner does not make this request before a settlement with the tenant, he cannot insist upon it afterwards. I cannot tell to what extent the claim on the goods policy may not have been questionable, or what the consideration for the surrender of the house policy amounted to. All that can be said is that the person who was prima facie entitled to the money thought it worth while to abandon it on certain terms. If that was done, as I must take it to have been done, before any such request as the statute requires, and without fraud (which is not averred), it is impossible to say that the Plaintiffs right could survive. On this ground, therefore, I must hold that the bill cannot be sustained, and it is not probable that the facts would allow of any useful amendment. Another objection presents itself, which it would be still more difficult to meet by any amendment. Supposing that it could he averred that a formal request was made in due time, their remains this difficulty: The Act of Parliament points to a request of this kind in order that the company may cause the money to be laid out in rebuilding, and I think it clear that they could not pay the money to the owner. The object of the provision is, in the interest of the public, to prevent persons from fraudulently setting fire to

their houses, and this is a fraud which of course might be committed either by the owner or the tenant. The company themselves are the persons to rebuild, in order that they may see that the money is really laid out in reinstating the property, and that it is judiciously expended. It is quite true in this case that the value of the house is stated to have been in excess of the insurance; but that does not affect the policy of the Act, which does not in any case give the owner the right to rebuild and claim the money, but requires the work to be done by the company. If this were otherwise, the purpose of the Act might be defeated by a landlord taking the policy money when there was a covenant by the tenant to rebuild. I come now to another branch of the argument, whether mandamus would not be the properer remedy, if any. It is settled that, where an entirely new right is given by statute, mandamus is the remedy, though it is otherwise where an old right only is enforced.…the Plaintiff, if right at all, ought clearly to have proceeded by mandamus; and I am inclined to think that the right course would have been to establish the case by mandamus, and then, if any difficulty occurred in obtaining payment, to come here to enforce it against the assets of the company.’

Notes: 1. A third party, for example, a mortgagee, may claim that insurance money should be used by the insured to reinstate the property. Indeed, a mortgagee of property has the statutory right to require reinstatement by the insuredmortgagor (see section 108(2) of the Law of Property Act 1925). Similarly, it is common for the terms of a hire purchase contract to provide

that the hirer effects insurance for the benefit of the owner. 2. In other cases, the court may infer from the surrounding circumstances that the insurance was intended for the joint benefit of the insured, for example a landlord, and a third party, the tenant. By this route, section 83 may, in effect, be extended to a Lloyd’s underwriter. [1312] Mumford Hotel Ltd v Wheler [1964] Ch 117 (CA) [By the terms of a lease the tenant covenanted to pay ‘a yearly insurance rent equal to the premium for keeping the property insured against comprehensive risks’ and the landlord covenanted ‘to keep the said messuage and buildings adequately insured against comprehensive risks.’ The lease did not contain a covenant to reinstate. The property was destroyed by fire and the tenant sought a declaration that the landlord was bound to reinstate the property]. Harman LJ: ‘In my judgment, the true question is not whether a covenant to reinstate should be implied, but whether the true inference is that Mrs Wheler [the landlord] is to be treated as insuring for her own benefit or for the joint benefit of herself and the company [the tenant]…The strength of the company’s case lies in its obligation to pay the premium, and its right to see that the policy is adequate. Why these provisions if it is to have no interest in the policy moneys? It was suggested that it got an

advantage because Mrs Wheler might choose to reinstate, and it would have a right to enforce it under the Act of 1774. The first of these is a shadow, and with regard to the second of these no one suggests that either party was aware of the statutory right. In my judgment the true implication is that Mrs. Wheler’s obligation to insure, done as it was at the tenant’s expense, was an obligation intended to enure for the benefit of both parties, and that Mrs Wheler cannot simply put the money in her pocket and disregard the company’s claim. She must, therefore, if called upon by the company so to do, use the money as far as it will go towards reinstatement of the property.’

13.2.2 Contractual Reinstatement An insurance policy may include a clause giving the insurer the option to require the insured to reinstate or repair. This has long been the case in property insurance (see Sadler’s Co v Badcock (1743) 26 ER 733), and is now frequently adopted in policies on goods as a safeguard against excessive and fraudulent claims. The election must be made within the period stated in the policy, or if none is stipulated, within a reasonable time of the claim. The insurer must communicate its election in unequivocal terms. Once an election is made, it is irrevocable. The effect is that the policy becomes a repair or rebuilding contract. As such, the insurer will be responsible for the quality of the contractor’s workmanship. The insurer is liable to replace like with

like even if the cost is greater than the sum insured. Where impossibility occurs after the election to reinstate is made, the doctrine of frustration may apply to discharge the obligation. Thus, the insurers may plead the Law Reform (Frustrated Contracts) Act 1943 (cf Brown v Royal Insurance, below, [1313], which was decided before the courts developed the doctrine of discharge by impossibility or frustration). If the insured has “obtained a valuable benefit” before the contract was frustrated, he or she may have to pay such sum as “the court considers just, having regard to all the circumstances of the case” (section 1(3) of the 1943 Act). If reinstatement becomes impossible before an election is made, the insurer will be liable to indemnify the insured. [1313] Brown v Royal Insurance Co (1859) 1 El & El 853 [A fire insurance policy reserved to the insurers ‘the right of reinstatement in preference to the payment of claims.’ The insured premises were damaged by fire and the insurers elected to reinstate but did not do so. In an action by the insured for damages or reinstatement, the insurers claimed that they were prevented from reinstating because a demolition order was issued by the Commissioners of Sewers under the Metropolitan Building Act 1855 and the premises were pulled down as being a structure in a dangerous condition and that such condition was not caused by the fire].

Lord Campbell CJ: ‘I am of opinion that our judgment ought to be for the plaintiffs. The case stands as if the policy had been simply to reinstate the premises in case of fire because, where a contract provides for an election, the party making the election is in the same position as if he had originally contracted to do the act which he has elected to do. The premises, then, having suffered this damage by fire, and the defendants not having reinstated them, do these pleas furnish a defence to an action for not reinstating? I am of opinion that they do not. The defendants undertook to do what was lawful at the time, and has continued to be lawful: that being so, the fact that performance has become impossible is no legal excuse for their not performing it; and they are liable in damages. That is the doctrine to be deduced from a class of cases to which I referred in my judgment in Hall v Wright (EB&E 746, 758). If any one undertakes to do a particular lawful act, and does not do it, it is no excuse that he cannot do it, if the law has not since rendered it unlawful. There was nothing unlawful in this contract; and, if it is impossible for the defendants to perform it, they must pay for that impossibility.’ Crompton J: ‘We have nothing to do with the mode in which the damages are to be assessed. I think the pleas are no answer to the action. There was not, and is not, anything illegal in what the defendants must now be considered as having contracted to do: and therefore the maxim…applies, “quod semel placuit in electionibus amplius displicere non potest.” The defendants are bound by their election; and, if the performance has become impossible, or (which is all they have shewn) more expensive than they had anticipated, still they must either perform their contract or pay damages for not performing it.’

Hill J: ‘I also am of opinion that the pleas are no answer. If we held that they were, the consequence would be that the defendants, although they themselves admit that they are bound to do something, would not be liable to do anything under their contract. The maxim…cited by my brother Crompton, applies here. I do not see that the performance of the contract has become impossible it has become more expensive, no doubt: but that is no answer.’

[1314] Robson v New Zealand Insurance Co Ltd [1931] NZLR 35 (Sup Ct) [A motor car policy gave the insurers the option of repairing the vehicle when damaged, or of allowing the owner to effect repairs himself and reimbursing him the cost. Clause 3 of the policy provided that ‘the insured shall not without the consent of the [insurers] repair or alter the damaged motor-car.’ When the vehicle was damaged the insurers elected to have repairs carried out by themselves. The repairs proved defective and the insured took the car to his own engineers to have the defects remedied. The insurers, relying on clause 3 of the policy, refused to reimburse him the cost]. Ostler J: ‘In my opinion, the judgment of the learned Magistrate was erroneous. Under the contract contained in the policy the insurance company had two alternative modes of performance of its obligations if and when they arose: it could either allow the insured to have his car repaired himself and pay him the cost, or it could itself effect the repairs and hand the car back to him duly repaired. The

effect of the exercise of this option on the part of the insurance company has been stated in…Brown v Royal Insurance Co Ltd [above], that where a policy of fire insurance gives; the insurer the option of electing either to pay the amount of the policy or to reinstate, and after the loss the insurer elects to reinstate, this does not constitute a fresh contract between the insured and the insurer, but the policy relates back and will be read as if it had originally been one simply for reinstatement. Following that principle the contract between the parties in this appeal must be read as though ab initio it was a contract to reinstate. But clause 3 of the conditions does not apply to such a contract at all. Clause 3 was intended to refer and to be applicable to the other option possessed by the insurance company — that is to say the option of allowing the insured to do his own repairs and paying him for them. In that case clause 3 applies, and the insured shall not without the written consent of the company repair or alter the damaged car. The condition has no application whatever to the alternative mode of performance which the company has chosen. The contract must be looked at as simply a contract by the company, if appellant’s car is damaged, to reinstate. If it makes a breach of that contract by failing to repair the car properly, then it is liable for an action for damages for breach of its contract. There is only one contract, and that contract is the one evidenced by the policy. That is the only contract which pledges the funds of the insurance company. But that contract is a contract to reinstate, and if the company breaks that contract it can be sued for breach of contract…With regard to damages, the measure will be the cost of repairing the car so as to put right the defective work done by the respondent company’s engineers. On the facts found in this case it seems clear that that must be the sum of £32 19s. 8d. Costs will be allowed to appellant, £7 7s., and disbursements.’

[1315] Times Fire Assurance Co v Hawke (1858) 1 F & F 406 [A newly constructed house, built by the insured who was a bricklayer, was destroyed by fire. The policy gave the insurers the option to reinstate which they elected to do and they employed a builder to effect the repairs. The insured claimed that the premises had been left in such a state by the builder that he was forced to expend large sums of money in order to properly reinstate them. The walls of the house had not been totally destroyed and they had, therefore, been incorporated into the new building. The insured claimed that the walls had been weakened by the fire and were of insufficient strength to bear the load of the building]. Channell B (addressing the jury): ‘As to the main question, the defendant was only bound to put the house substantially in the same state as it was before the fire; and was not bound to pull down the old walls and rebuild them entirely on account of any defect in their foundation. It was enough if, incorporating what remained of them, the new walls were as secure as the old ones were.’

[1316] Anderson v Commercial Union Assurance Co (1885) 55 LJQB 146 (CA) [The plaintiff had mortgaged the insured premises and defaulted on his repayments. In December 1882 the building was destroyed by fire and shortly thereafter the mortgagees were granted a possession order by virtue of court proceedings that were

initiated in June 1882. The insured had carried on his business from the premises and machinery and plant were substantially damaged by the fire. The insurance policy effected with the defendant insurers contained a clause (condition 7) which provided that: ‘the company may if it thinks fit reinstate or replace property damaged or destroyed instead of paying the amount of the loss or damage.’ The insurers, having elected to reinstate the machinery and plant, did so within a reasonable time after the building itself was restored, but after the mortgagees had obtained possession of the premises. The plaintiff argued that in the circumstances he was entitled to payment of the amount of the loss or damage]. Lord Esher MR: ‘In this case it was argued on behalf of the company that they had a right to say that they would reinstate or replace the things insured in the place in which they were before the fire, and that if the place was destroyed or taken out of the possession of the assured so that the company could not exercise their option to reinstate or replace the things in that place, they had the right to say that they would neither reinstate or replace them nor pay the amount of the damage. It is, therefore, necessary to consider what construction is to be put upon the seventh condition. We have come to the conclusion that the words “reinstate or replace” should be thus applied: if the property is wholly destroyed the company may, if they think fit, replace it by other things which are equivalent to the property destroyed instead of paying in money the amount of the loss; or, if the goods insured are damaged and not destroyed by fire, the company may exercise their option and reinstate them, or, in other words, may repair them and put them in the state

in which they were before the fire. It is idle for the company to contend that if the place in which the things were is destroyed they may elect to reinstate or replace or pay the amount of the loss, and then do neither. Their contention to that extent was wholly bad. But that of the plaintiff was equally wrong — namely, that if the goods could not be reinstated or replaced in the place in which they were before, either because the place itself was destroyed or because the plaintiff could not legally get to that place, he had a right to be paid in money. There is nothing about locality in the condition, and the mere fact of the plaintiff not being able to put the goods again in the same place could not give him the right to be paid by the company. The company, therefore, had an option, which they exercised, and it appears that they reinstated or repaired the goods insured after the mortgagees had taken possession of the premises. They have, therefore, done what the option entitled them to do, and what under their policy they had under taken to do. But that does not allow them to say that they will repair the things at the exact place where they were before, and that if the assured will not allow them to go to that place they will neither do the repairs nor pay for them. If the plaintiff was unable to put the things in the place where they were before the fire, he had a right to say that the defendants must do what was reasonable under the circumstances, and he might have taken them to another place within a reasonable distance of the place where they were before the fire, and then have requested the defendants to repair them there or to take them to their own place and there repair them. The plaintiff however, took a wrong view of the matter, for he insisted upon leaving the things where the defendants had placed them and then required the defendants to pay him for them. The plaintiff cannot complain that the defendants have repaired the goods. But if the defendants have dealt with the goods so that the plaintiff cannot get at them, and, as I suspect,

made some arrangement with the mortgagees as to their having the machinery which had been repaired by the defendants, the plaintiff might have a right of action. But that action would not be the present one, which is brought upon the policy. I therefore think that the defendants have a good defence to this action; and having succeeded, the appeal must be dismissed.’

Bowen LJ: ‘The words of the condition shew that it was introduced for the benefit of the defendants, and to protect them from liability to pay the full pecuniary damage. From the collocation of the words it would seem that “reinstate” is used with reference to property which has been damaged, and “replace” to property which has been destroyed. In construing the word “reinstate” it must be remembered that it is a general word used in a policy which may refer to the insurance both of buildings and also of chattels. The first question with which we have to deal is where chattels have been damaged. There the property in the chattels remains in the person who was the owner before the fire, and under the condition the defendants are entitled instead of paying the amount of damage to make the chattels as good as they were before the fire. But when one is dealing with property in the nature of chattels, the term “reinstate” means to replace the chattels not in situ but in statu; and all that the defendants are bound to do is to make the chattels as good as they were before the fire. What happened to the plaintiff was this: — he was turned out of possession of the premises between the time when the fire occurred and the time when the defendants repaired the goods insured. The plaintiff chose to stand upon his rights, and now says that as the building has been destroyed or damaged it is impossible for the defendants to reinstate the goods, and therefore they are liable to pay the amount of the loss or damage. The plaintiff made a mistake in thinking that what had happened

had made it impossible for the defendants to perform the alternative condition. It was possible for he defendants to reinstate the goods, although it is true that they would have to do so on ground which was no longer his own. It was, however, argued on behalf of the defendants that they would be discharged from performing either alternative of the condition if what had happened made it impossible for them to reinstate the property; and that as their bargain was off they could not be compelled either to pay or to repair. But that is a monstrous contention. It is clear law that if one of two things which had been contracted for subsequently becomes impossible, it becomes a question of construction whether, according to the true intention of the document, the obligor is bound to perform the alternative or is discharged altogether. It is hopeless on the part of the defendants to contend that upon the construction of this document it was the intention of the parties that if one of the alternatives became impossible the defendants were to become altogether free. However, reinstatement here was quite possible. The defendants by reinstating the property have done what they were bound to do, but it is no doubt possible that they have done something which they bad no right to do, and in respect of which the plaintiff in whom the property in the goods remained may have a right to complain. If they have done nothing wrong to his property, and have themselves neither taken nor placed it where they had no right to place it, they are entitled to say that they have done all that they were bound to do under the condition, and the plaintiff cannot insist upon payment of the sum which he claims.’