Good Faith and Insurance Contracts

Peter MacDonald Eggers and Sir Simon Picken

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CHAPTER 9 Modification of the duty of disclosure at placing

Modification of the duty generally

9.01 The duty to disclose material facts, whether it arises as a matter of law or contract, exists or is made whole by virtue of the contract which is entered into, and so the scope of the material facts to be revealed naturally may be defined or modified by the contract itself. For example, the policy may provide that the duty is discharged in specified instances1 or the policy may state that specific facts must have been disclosed.2 The parties may agree in their contract that the assured’s duty of disclosure may be enlarged,3 restricted4 or waived,5 or that the remedies for a non-disclosure or misrepresentation are varied from those available at common law or under a statute (such as by means of an innocent non-disclosure clause).6 Even in such cases of modification, the practice of the relevant market may assist

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in defining the duty on the assured.7 Where the duty of disclosure is sought to be modified by the contract, it will require unambiguous language to achieve that result, the clause being construed against the party who benefits from the intended modification.8 9.02 In so far as the duty arises pursuant to the Insurance Act 2015, the modification of the duty that puts the assured in a worse position – in order to be valid and effective – must comply with the transparency requirements of the 2015 Act, which are aimed to ensure clarity and certainty in the modification of the duty.9 By section 16, if, however, the modification would put the assured in a worse position than that under the 2015 Act, in order to be effective, there are two requirements that must be fulfilled: (a) the disadvantageous term must be clear and unambiguous as to its effect; and (b) the insurer must take sufficient steps to draw the disadvantageous term to the assured’s attention before the contract is entered into or the variation agreed, or the assured (or its agent) must have had actual knowledge of the disadvantageous term when the contract was entered into or the variation agreed. In determining whether these requirements have been satisfied, the characteristics of the insured persons of the kind in question, and the circumstances of the transaction, are to be taken into account. Section 16 does not apply in relation to a contract for the settlement of a claim arising under a non-consumer insurance contract. 9.03 In so far as the duty arises pursuant to the Consumer Insurance (Disclosure and Representations) Act 2012, section 10 provides that any modification of the duty that puts the consumer assured in a worse position will be of no effect.10 Section 10 does not apply in relation to a contract for the settlement of a claim arising under a non-consumer insurance contract. 9.4 Under both the 2015 Act and the 2012 Act, basis clauses are prohibited and any contractual attempt to introduce a basis clause will be ineffective.11 9.05 The duty may also be modified unilaterally by the insurer by virtue of the insurer’s questions put to the assured (whether orally or in a proposal form or howsoever),12 which may suggest that the insurer is not interested in certain categories of information, even if objectively material,13 or that the insurer is treating particular categories of facts as material.14 The mere fact, however, that the assured is required to complete a proposal form is not in itself a ground for modifying or relieving the assured of his obligation of disclosure.15

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Further, the insurer may waive disclosure in the ways discussed above, even if the waiver is not effected by agreement or by the nature of the questions put to the assured.16

Warranties and basis clauses

The nature and effect of basis clauses at common law

9.06 The contract of insurance may define the extent of disclosure required of the assured. In this way, the insurer may dispense with disclosure of objectively material facts. Alternatively, the insurer and the assured may agree in their contract that certain facts are true, whether or not they are material and whether or not the truth of such facts as declared by the assured induced the making of the contract. This latter device is achieved by the inclusion of a warranty in the policy that certain facts as declared by the assured are true. Often, the declaration is made in the proposal form on which the policy is based, in which case the policy and the proposal form have to be read together to make sense of the whole.17 If such a warranty exists, the truth of the facts warranted are treated as part of or as the basis of the contract and if such facts are demonstrated to be false, the contract is treated as discharged from both parties’ perspective. Breaches of warranty will discharge an insurer from liability, automatically without further action by the insurer,18 as from the time of the breach.19 In the case of facts that are warranted to be true at the time of the contract, the effect of the falsity of such facts is to discharge the insurer from the time of the contract so that it could be said that the risk never attached. Often such warranties are accompanied by clauses that automatically render the contract void in the event that there has been a false representation.20 9.07 This warranty must be introduced into the contract by clear and unambiguous language;21 any ambiguity will be resolved in favour of the assured.22 If the representation

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finds its way into the written body of the policy, the representation generally will be a warranty in so far as it bears upon the risk insured.23 The warranty may be inserted in various forms, such as “it is warranted” or “it is declared” that the facts represented are true and/or that the assured has not withheld any material facts, accompanied24 by a provision that such declarations are “incorporated into” or are “the basis of” the contract or are conditions precedent to the contract itself or liability under the contract.25 In this section, such clauses generally shall be referred to as “basis clauses”. 9.08 Where a basis clause is found only in the proposal form and not in the policy, the authorities suggest that a warranty of truth of the statements made in the proposal form is created.26 However, it is suggested that this is a flawed approach, and that the usual construction should be that no such warranty was intended by the parties, for the following

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reasons. First, the parties probably intended that the entirety of their contractual relations is to be governed by the policy and not by any pre-contractual documents, such as the proposal form. Secondly, the basis clause is intended to have effect as a warranty; yet warranties are clauses that must be found in the body of the policy and not in any non-contractual document, such as the proposal form, unless the policy expressly incorporates such documents by reference.27 Thirdly, such clauses are to be construed strictly against the insurer.28 If there is no reference to the proposal form in the policy, it is an equally, if not a more, plausible construction of the document that the parties intended that there be no basis clause in the contract. 9.09 There is a fine line of distinction between basis clauses and the duty not to misrepresent material facts, as opposed to the obligation of disclosure, as with every representation of fact there is an implied representation that the fact represented is true; in order to establish the insurer’s entitlement to relief for misrepresentation, the representation must be material and there must be inducement to contract on the basis of the truth of the fact represented. Whether a representation is said expressly to be the basis of the contract would seem to offer little practical meaning. However, the inclusion of a basis clause is to ensure that the insurer need not prove materiality or inducement in order to claim relief for misrepresentation or, where there is a warranty of full disclosure, non-disclosure. Such requirements of materiality29 and inducement30 are dispensed with if there is a warranty or basis clause as described above. Further, the fact must be absolutely true in every respect31 and not just substantially true, as warranties must be complied with precisely.32

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9.10 Given the demands of warranties in insurance contracts, the intention to include a warranty in the policy must be manifested by the clearest language. Warranties may be one of two types, namely those that are descriptive of the risk so that any “breach” merely indicates that the policy will not respond to a claim based on that “breach”, and promissory warranties, the breach of which discharges the insurer from liability under the policy, even if the claim would otherwise be allowable.33 9.11 The present topic concerns promissory warranties.34 Accordingly, the assured may argue that the warranty in question is in fact a descriptive warranty in order to avoid the consequences of a breach of promissory warranty. Such an attempt was made in Yorkshire Insurance Co Ltd v Campbell,35 where a proposal form that contained the description of a pedigree of a horse was expressed to be the basis of a marine policy. The Privy Council (on appeal from the High Court of Australia) held that all words used in a policy are words of contract and must be given effect and that prima facie the words qualifying the subject-matter of the insurance were words of warranty. In this case, the basis clause constituted an express insertion of a warranty and therefore the warranty had to be complied with exactly, whether or not it was objectively material to the risk.36 Whether the words used in the policy amount to a warranty must be determined having regard to the nature of the transaction, the known course of business and the forms in which such transactions are given effect, but not to peculiar facts existing in respect of the risk. Taking these strictures into account, the court concluded that the express clause in this case constituted a warranty.37 9.12 This decision is to be contrasted with the decisions in Provincial Insurance Co Ltd v Morgan,38 Overseas Commodities Ltd v Style39 and Iron Trades Mutual Insurance Co Ltd v Companhia de Seguros Imperio.40 The last two cases are explicable by the fact that there were no express words of warranty41 and the relevant words were treated merely as words of description. However, in the first of these cases, there was an express warranty, together with a basis clause.42 The assured was asked to state the purpose of the use of the lorry that was to be insured and the nature of the goods to be carried. The assured replied “delivery of coal” and “coal” respectively. After the lorry one day delivered timber and coal, it sustained a collision while only coal was being carried. The assured presented a claim under

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the policy. The House of Lords held that a warranty must be strictly but reasonably construed and must be strictly complied with. As the question and answer in this case could not be interpreted as suggesting that the assured would not use the lorry for purposes other than the carriage of coal, the words had to be construed as a description of the risk and not as a warranty.43 Accordingly, provided that the lorry was carrying only coal and nothing else, there was cover under the policy; if, however, the lorry had carried timber and coal at the time of the collision, there would have been no cover under the terms of the policy. Ultimately, therefore, even where there is a basis clause, whether a warranty is imported by those terms is a question of construction, dependent upon the connection of the term to the essence of the risk insured.44 In the usual situation, however, where a proposal containing statements of fact is rendered the basis of the contract, the likelihood is that a warranty is created and must be complied with to the letter. 9.13 The nature and effect of basis clauses have been examined in a number of cases. The basis clause is accepted as a warranty of the truth of the representations of the assured, usually recorded in a proposal form, as confirmed in Wheelton v Hardisty.45 In Macdonald v The Law Union Fire and Life Insurance Company,46 the court held that it did not matter, if the insurer wished to repudiate liability, that the assured was not aware of the falsity of the representation,47 as the basis clause was a warranty of truth of the representation and formed part of the contract so that moral culpability was not an essential element of the breach of duty.48 This quality of the basis clause is no different from the insurer’s cause of action based on a misrepresentation. 9.14 In Thomson v Weems,49 the House of Lords applied the law generally applicable to insurance warranties as laid down in Anderson v Fitzgerald50 and held that the court must look at the natural and ordinary language of the clause so that any ambiguity is construed against the insurer. If the parties wish to agree that the truth of the representation is to be warranted, the parties are free so to agree. By such an agreement, the parties accept that the fact represented (or the confirmation that the assured has withheld no material circumstance) need not be material as determined by a prudent underwriter, as the parties themselves are treating the fact as material. Any statement that bears on the risk insured and is made the basis of the contract must be construed as a warranty, which must be complied with strictly, and is a condition precedent to the attachment of the risk.51 It has also been

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said that the basis clause establishes that the accuracy of the answers to the insurer’s questions will be a condition precedent to the validity of the policy.52 9.15 The Court of Appeal in Joel v Law Union and Crown Insurance Company53 warned against the existence of basis clauses,54 which tended to find their way into consumer insurance contracts. The insertion of such basis clauses resulted in the making of an absolute warranty of truth and so must be construed against the insurer. The clearest language would be required to render this a warranty of truth. The potential onerousness of a warranty was exemplified by Fletcher Moulton LJ, who said that there were some questions posed by an insurer that cannot truthfully be answered by anyone, even if it is believed that the answer is true. The learned judge supposed that the assured was asked whether he had suffered from any disease and concluded that the most skilled doctor after a prolonged scientific examination could not answer such a question with certainty.55 Whilst there is no reason that an assured cannot answer such a question literally, such as with the response “To the best of my knowledge, I have suffered from no disease”, many applicants for insurance who are unaware of the necessity of literal answers are unlikely to adopt a lawyer’s stance. Hence, the insurance industry in the United Kingdom has resolved not to adopt the mechanism of such warranties in their policies issued to private assureds resident in the United Kingdom.56 Indeed, in a number of jurisdictions, legislation has been passed to rob the warranty of its draconian effect and to require independent proof of materiality57 or inducement.58 9.16 Whilst the Court of Appeal acknowledged that the parties are free to agree what circumstances constitute the basis of the contract and are material to be disclosed by the assured, in the present case where the assured declared that the facts represented were true to the best of his knowledge and belief, such a declaration did not amount to a warranty, as matters of opinion cannot be the subject of warranties of accuracy of fact.59 Furthermore, where the questions asked of the assured invite statements of fact which generally are the subject of expert knowledge, it may be assumed that the question seeks only the assured’s personal state of knowledge on the matter, as opposed to the actual state of affairs, objectively determined.60

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9.17 Where the proposal form or the policy includes the assured’s declaration that the answers in the proposal form (or that there has been no suppression of material facts) or any other pre-contractual representation are true to the best of his knowledge or belief, and where the policy includes a warranty that that declaration is true, then the warranty is breached only if the assured subjectively believes that his declaration is untrue.61 If the policy is composite designed to indemnify each assured in respect of the other assured’s fraud and one of the assureds signs the proposal form on behalf of all of the assureds, knowing that his answers are untrue, and if the warranty is qualified by the words “to the best of my knowledge or belief”, then the warranty has been construed as discharging the insurer’s liability only as regards the signatory’s contract and not the co-assureds’ contracts of insurance.62 This is probably because, even though the statement that is warranted to be true is technically untrue, it would not have been expected by the parties that the co-assureds’ insurances would be prejudiced by the fraudulent knowledge of the signatory, unless of course the co-assureds were privy to the fraud. Where, however, the fraudulent signatory completes the proposal form and signs the declaration that his answers are true, and there is no qualification as to the signatory’s knowledge or belief, then all that matters is whether or not the answers are true. If not, then the warranty will discharge all of the insurance contracts included within the composite policy.63 9.18 The effect of a basis clause in the context of reinsurance came to light in Australian Widows’ Fund Life Assurance Society Ltd v National Mutual Life Association of Australasia Ltd.64 In this case, the original policy on the life of the original assured incorporated a statement of the health of the life assured that was declared to be the basis of the policy. The reinsurers accepted the risk on the same terms on which the original policy had been issued by the reassureds, “by whom, in the event of claim, the settlement will be made”. The reassureds settled the original claim in a bona fide and business-like fashion. Notwithstanding the approach of the reassureds in settling the claim, it was held by the Privy Council (on appeal from the High Court of Australia) that, as the statement was untrue and the reinsurance being a separate contract from the original policy, the condition precedent to liability under the policy (namely, the truth of the representation as to the health of the assured) was not satisfied so that the reinsurance company “is not and never was liable on the policy of re-insurance”.65

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9.19 In a perceptive judgment in Stebbing v Liverpool and London and Globe Insurance Co Ltd66 Viscount Reading CJ noted that when a party relies upon a misrepresentation to rescind the contract, he must prove the falsity of the representation made, the materiality of the fact represented and the fact that he was induced to enter into the contract by virtue of the misrepresentation. However, where the parties have agreed a basis clause, they have agreed to dispense with two of these questions, namely materiality and inducement. Further, his Lordship commented, being relevant to the issue at hand (the application of an arbitration clause), that in bringing the contract to an end, the representee was relying on a clause in the contract and not seeking to avoid the contract, albeit in this case the policy provided that the truth of the assured’s representations was a condition precedent to liability.67 9.20 The effect of basis clauses was explained authoritatively by the House of Lords in Dawsons v Bonnin Ltd.68 In this case, a lorry was insured against fire and third party risks. The assured completed a proposal form and stated the usual address at which the lorry would be kept as the assured’s place of business in Glasgow, whereas the lorry was usually garaged elsewhere. The proposal form was expressed to be the basis of the policy, which further provided that the policy was automatically void in the event of a material misrepresentation. The court held that if the parties contract on the basis that the assured will provide accurate and truthful answers to questions put by the insurer, whether material or not, the contract must be fulfilled as a condition for the assured to recover.69 This is an express warranty. It does not matter that the fact that is the subject of the warranty is, at the time of the representation, a present fact or promise that must be observed in the future (such as the garaging of the insured lorry in this case); that is, it does not matter that the warranty is a continuing warranty.70 The House of Lords, however, was split on the relationship between the basis clause and the clause that rendered the policy automatically void in the event of a material misrepresentation; the majority held that the existence of such a clause did not alter the effect of the warranty introduced by the basis clause and thus did not require proof of materiality. This conclusion had earlier been supported by the Privy Council in Condogianis v Guardian Assurance Co Ltd.71 The nature of basis clauses as warranties and the

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consequent treatment of the facts warranted as material, thus requiring no separate proof for the purposes of obtaining relief if the representation is untrue, has been confirmed in many cases so as to be undeniably trite law.72 In Genesis Housing Association Ltd v Liberty Syndicate Management Ltd,73 Jackson LJ said “This principle, which has been formulated in a variety of ways over the last 200 years, has been the subject of some criticism by judges, text-book writers and the Law Commission.” The position has now been reformed by section 6 of the Consumer Insurance (Disclosure and Representations) Act 2012 and section 9 of the Insurance Act 2015. 9.21 In Schoolman v Hall,74 the Court of Appeal75 made it clear that while the basis clause introduced a warranty it dispenses with the requirement of materiality since the parties themselves have agreed that the fact warranted as true is material for the purposes of the contract; the court held that the existence of the warranty by itself did not relieve the assured of his general common law duty of disclosure of material facts76 (unless, of course, the insurer has waived such disclosure).

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Alleviation from basis clauses and the effect of legislation aside from the Consumer Insurance (Disclosure and Representations) Act 2012 and the Insurance Act 2015

9.22 As with all insurance warranties, the assured’s failure to comply with the warranty introduced by the basis clause may be excused where the warranty ceases to be applicable to the contract because of a change in circumstances, where the lack of compliance has been waived by the insurer77 or where the contract itself qualifies the warranty or the remedy for its breach.78 Furthermore, if a fact is warranted as true and that fact has been erroneously or mistakenly recorded in the contract, the court may be able to rectify the statement, provided the doctrine of mistake allows the rectification in the circumstances of the case, and so thwart a breach of warranty79 or if the mistake is so obvious that the insurer must be regarded as being put on enquiry.80 However, if the assured becomes aware of the mistake prior to the contract being made, he should inform the insurer of the error or he will have to suffer the consequence of his omission.81 9.23 Where a misrepresentation has been made and that representation has been incorporated as part of the contract of insurance by the basis clause, it has always suited the insurer to rely only on the basis clause. It may, however, be occasionally advantageous to the insurer to rely on the simple breach of the duty of the utmost good faith. Is such a choice available to the insurer or must the insurer limit his sights to the breach of warranty? Traditionally, under the ordinary law of misrepresentation, where a representation had been incorporated into the contract, the innocent party had to sue for breach of contract, not misrepresentation, unless there had been fraud.82 However, section 1(a) of the Misrepresentation Act 1967 provides that the remedy of rescission, subject to the court’s discretion, is available for any misrepresentation, even if the representation has become a term of the contract.83 This is strongly suggestive of the availability of an option to the insurer to rely

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upon a breach of the legal duty not to misrepresent84 material facts, whether fraudulent or not,85 so as to rescind the contract.86 9.24 There is a qualification to the effect of basis clauses that should be borne in mind. This qualification relates to section 148(1) and (2) of the Road Traffic Act 1988, which render ineffective any term in the policy that seeks to “restrict” the insurer’s liability to indemnify an assured in respect of his liability in various respects to a third party arising from the use of a motor vehicle, by reference to a number of criteria, including the age, mental and physical condition of the driver and the condition of the vehicle. If the policy warrants the truth of facts relating to such matters, which would not be material under the general law, such basis clauses would not be effective. For example, if the assured untruthfully answers a question in a proposal form that he is healthy in all respects, whereas in fact he fails to disclose that he suffers from a chronic infection of an in-grown toenail, which has no effect on his ability to drive, such a fact may be treated as immaterial, but a basis clause would expose the assured to a claim for breach of warranty. Section 148(1) would neutralise this warranty. (The difficulty with this analysis is that it assumes that the mere asking of the question might render the fact material as a matter of law, independently of the policy.87 It is submitted that the mere asking of a question by the insurer might enlarge the scope of materiality, but not to infinity, so that there must be some restraint on the notion by reference to the attitude of the prudent underwriter and the connection of the fact to the risk at hand.) 9.25 The validity of basis clauses was open to question under the Unfair Terms in Consumer Contracts Regulations 1999,88 which applied to consumer insurance contracts concluded before 1 October 2015, and under section 62(1)–(5) of the Consumer Rights Act 2015, which applies to consumer insurance contracts concluded on or after 1 October 2015. This legislation renders unenforceable any contractual term that is unfair in the sense of creating an imbalance in the rights and obligations of the parties to an insurance contract, contrary to the requirement of good faith, as between a professional insurer and a consumer. The Directive implemented by the 1999 Regulations provided that terms that define the insured risk and the insurer’s liability will fall outside the scope of the Regulations, as they are taken into account in defining the premium.89 9.26 The 2015 Act does not contain an equivalent provision, but it is likely that the 2015 Act would in this respect be interpreted in light of the Directive. In any event, there is some cogency in the suggestion that basis clauses which render material the existence of facts that objectively have no bearing on the insurance contract or the insured risk, should be

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open to assessment as unfair,90 having regard to all the circumstances at the time of conclusion of the contract and the terms of the contract.91 At least, the Directive and the 2015 Act require that terms offered to the consumer should be in plain, intelligible language and that any ambiguity should be resolved in favour of the consumer assured.92

The Consumer Insurance (Disclosure and Representations) Act 2012 and the Insurance Act 2015

9.27 Basis clause operates by warranting the truth of a pre-contractual representation made by the assured, such representations often – but not always – being made in a proposal form. The warranty is such that if the pre-contractual representation is untrue, it would at common law discharge the insurer from liability under the insurance contract. This would be so, depending on the terms of the relevant warranty, whether or not the representation was material or induced the insurer to enter into the insurance contract. 9.28 Such provisions – basis clauses – are now prohibited by section 6 of the Consumer Insurance (Disclosure and Representations) Act 2012 and by section 9 of the Insurance Act 2015. Both statutory provisions operate by stating that a representation made by an assured in connection with a proposed insurance contract, or a proposed variation to an insurance contract, “is not capable of being converted into a warranty by means of any provision of the … insurance contract (or of the terms of the variation), or of any other contract (and whether by declaring the representation to form the basis of the contract or otherwise)”. By section 10 of the 2012 Act and section 16(1) of the 2015 Act, it is not permissible to contract out of this prohibition. 9.29 Accordingly, basis clauses are no longer permitted. However, it is worth reflecting on what a basis clause is for the purpose of this prohibition and the extent of the prohibition. Although the statutory language is potentially broad in its effect, paragraphs 83–84 of the Explanatory Notes accompanying the Insurance Act 2015 state:

“Under the current law, an insurer may add a declaration to a non-consumer insurance proposal form or policy stating that the insured warrants the accuracy of all the answers given, or that such answers form the ‘basis of the contract’. This has the legal effect of converting representations into warranties. The insurer is discharged from liability for claims if the insured made any misrepresentation, even if it was immaterial and did not induce the insurer to enter into the contract. This section [section 9 of the 2015 Act] abolishes basis of the contract clauses in non-consumer insurance. Basis of the contract clauses in consumer insurance were abolished by section 6 of CIDRA. It remains possible for insurers to include specific warranties within their policies.”

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