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The nature of the insurance relationship, as it is described by Lord Mansfield in Carter v Boehm

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The nature of the insurance relationship, as it is described by Lord Mansfield in Carter v Boehm1, renders important and justifies the recognition by insurance contract law of the doctrine of utmost good faith: “…The special effects by 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 risk, as if it did not exist…”. The doctrine of utmost good faith embraces the duty of disclosure and non-fraudulent misrepresentation which are both subject to the concept of materiality2 ,which has engendered a great deal of debate in the courts over recent years.

In order to acquire a balanced view of the current law governing utmost good faith in marine insurance, a brief analysis of the historical background of the pre-contractual duty of utmost good faith would be rather helpful.

The major issues arise from the definition which can be chosen to define ‘a material fact’ which would satisfy the threshold of influence upon the prudent underwriter. In the case of Berger & Light Diffusers Ltd v Pollock3, Kerr J. held that in order for a non-disclosure to allow the insurer to avoid the contract under the s. 17 of 1906 MIA4 , it had to be objectively and subjectively material to the inducement of the insurer into the contract.

A few years later in the case of Container Terminal International Inc (C.T.I.) v Oceanus Mutual Underwriting Association ( Bermuda) Ltd5, at first instance the court found for the assured. The court supported the idea that section 18(2) of the Marine Insurance Act 1906 refers to situations where the non-disclosed circumstance would have guided the ‘prudent underwriter ‘into a ‘different decision’. Thus, the insurer would either have refused to undertake the risk or would have charged a higher premium.

C.T.I. v Oceanus6 was appealed in favour of the underwriters. The Court of Appeal sought to reject both the decisions of Berger v Pollock7 and the decisions of the court of first instance. Thus, a lower threshold was established for the underwriter to satisfy in order to avoid the policy. The insurer did not have to prove that the non-disclosed information had a ‘decisive influence’ upon his judgement in undertaking the risk. The mere desire of the underwriter to have been aware of the undisclosed information would be sufficient to avoid the contract.

The decision in the CTI v Oceanus was extensively criticized. The ‘mere influence’ test as it was known, contradicted the principle laid down by earlier cases such as the Ionides v Pender8. Thus, the position was modified in the leading case of Pan Atlantic v Pine Top9.

The Pan Atlantic case reached the House of Lords illustrating the difficulty the courts experienced in resolving the pending issues related to misrepresentation and non-disclosure. The point of the appeal that full and accurate disclosure would have had a decisive influence on the mind of the insurer was the cause of some disagreement between the Lordships. The House, on a bare minority, rejected the defendant’s submission and held that it was not necessary for the insurer to show that the fact that was misrepresented or not disclosed would have had a decisive influence on his mind, in the sense that he would have acted differently if he had known about it.

There was a strong dissent from Lord Templeman and Lord Lloyd both of whom suggested that nothing could be construed as being decisive if the insurer would not have acted differently; “acting differently” here meaning that the insurer would not have accepted the same risk at the same premium. Lord Templeman, stated quite clearly that: “…the judgement of the prudent insurer cannot be said to be ‘influenced’ by a circumstance which, if disclosed would not have affected the risk or the amount of the premium”10.

On the other hand, Lord Mustill concluded “that there is to be implied in the 1906 Act 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 contract11.”

Therefore, according to the test adopted by the House of Lords, a circumstance or presentation will be regarded as material if it would denote an effect on the mind of a prudent insurer in weighing up the risk. The House further stated that materiality of a circumstance or presentation alone is not sufficient to confer upon the insurer the right to avoid the contract in order to be able to avoid the contract, the insurer additionally has to show that he was actually induced to enter the contract on the relevant terms as a result of non-disclosure or misrepresentation.

While the scope of the pre-formation doctrine of utmost good faith has attracted considerable attention in the case low over the past thirty years, section 17 of 1906 M.I.A. leaves no room for debate with respect to remedies for breach. The innocent party ‘may avoid the contract’. This means that the contract may be set aside retrospectively. The insurer can recover any claims money paid out in the past and need only return the premium12.

The pre-contractual negotiations are the part in the policy formation, which was intended to be mainly governed by the duty of utmost good faith. However, if s.17 is carefully read, it could be seen that no time restrictions have been imposed on the duty of good faith. This indicates that the duty has not been limited to a pre-contractual stage and it may arise in specific post-contractual situations.

In the recent case of the Star Sea13, the Court of Appeal stated that the doctrine of utmost good faith did not cease to influence the actions of the parties until the contract was at an end and no adversarial relation had occurred. Lord Hobhouse of Woodborough summarized the view of the court as follows: “…the nature of the relationship between the assured and insurer is very different before and after the commencement of litigation. Before the litigation the parties relationship is contractual, so it is natural to expect the contractual principles, including remedies, to govern the relationship. However, after the commencement of litigation, the nature of the relationship changes and it is the procedural rules which determine the relationship between the parties…”.

The assured is under a post-contractual duty of good faith in cases where there is a variation to extend the policy terms or cover. In Fraser Shipping Ltd v N.J Colton & Ors14, the insured did not disclose to the insurer certain matters that took place when they agreed to vary the insurance to change the port of destination. The vessel stranded on an island and when the assured claimed on their policy, the insurer refused payment on the ground of breach of utmost good faith duty. Potter,L.J., held that the insurers were entitled to avoid the policy as varied.

The same principle applies where the underwriter is entitled to charge an additional premium, as occurred in The Litsion Pride15, where a fraudulent claim by the assured was held to breach the duty of uberrimae fidei.

Finally, the assured must act in good faith when he wishes to rely upon a held covered clause. A held covered clause gives an opportunity to an assured to extend the scope of cover on giving notice to insurers and agreeing on additional premium and other terms imposed by insurers. McNair J held in the leading case Overseas Commodities Ltd v Style16 that: “…the assured could not rely upon the held covered clause because in order to do so they must act with the utmost good faith towards the underwriters, this being an obligation which rests upon them throughout the currency of the contract…”.

There is a further point, which needs to be clarified as to the scope of post-contractual duty of good faith arising during variation of the contract, since there is no reference to “materiality” in s.17, unlike ss 18-20 of 1906 M.I.A. Is the assured under an obligation to disclose a circumstance which has arisen since the conclusion of the contract that would be material were the risk being placed for the first time but that is not material to the variation17? The answer is given by Hobhouse J. in Iron Trades Mutual Ins Co. v Companhia de Seguros Imperio18 : “…When there is an addition to a contract, as where it is varied, there can be a further duty of disclosure but only to the extent that it is material to the variation being proposed…”.

Since variation of contract extends the scope of cover, the duty of good faith for the extention might be considered be as similar to the pre-contractual duty. This is the case because in both instances the insurer is required to undertake a new risk and in this respect the assured’s conduct becomes crucial. However, the same could not be said for the utmost good faith duty which arises in the claims context. Here the insurer does not undertake a new risk, so the situation is not similar to pre-contractual stage18.

Therefore, section 17 should not have application in the claims context. That would be consistent with the analysis of the majority of the Court of Appeal in Orakpo v Barclays Ins Services19which analysed the duty of dealing with the claim as a contractual obligation and characterized the breach (by presenting a fraudulent claim) as going to the root of the contract and entitling the insurer to be discharged from further liability under the contract.

Furthermore, in Banque Keser Ullmann SA v Skandia (UK) Ins. Ltd20 it was held by the Court of Appeal that breach of the pre-contractual duty of disclosure in s.18 only gives rise to a right to avoid the insurance contract and nothing else. A correlation between an impied term and damages was established and it was decided that since the pre-contractual duty of good faith was not derived from an implied term of the contract, no damages were recoverable. But what about an award of damages for a breach of the post-contractual duty of good faith which arises in the claims context? Is that not derive from an impied term of the contract?

The courts have repeatedly ruled against the award of damages for a breach of the duty of utmost good faith. Although, in Toomey v Eagle Star Insurance Co ( No2 21) the court of Queen’s Bench decided that an action for damages for non-innocent misrepresentation, under s. 2(1) of the Misrepresentation Act 1967, is not precluded by a clause referring only to avoidance or cancellation. Lastly, the issue of proportionality has tried to find some middle ground as way of remedy, since it can be argued that rescission could be extreme certain situations. Major arguments have been raised against it, since the established customary practice of insurance would be threatened. The difficulty of identifying the degree of proportionality and thus the amount to be paid would not only prove to be almost impossible but it would also vastly increase the amount of litigation.

To sum up, a path towards a sensible doctrine of utmost good faith is emerging, but s. 17 and its inflexibility of remedy have not been addressed satisfactorily. Confining s.17 to the pre-formation doctrine appears to be the key to progress. Once s.17 is so confined, various post-formation duties can be recognized that will operate according to general contract law. Thus, the duty arising in the context of handling claims under liability policies could attract a damages remedy. Whether the courts will have the courage to take this path remains to be seen.

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