Good Faith and Insurance Contracts

Peter MacDonald Eggers and Sir Simon Picken

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CHAPTER 17 The loss of the insurer’s right to exercise a remedy or to rely upon a breach of warranty

Background

17.01 Where one party to an insurance contract is guilty of material non-disclosure or misrepresentation, in breach of the duty of good faith, the insurance is not automatically avoided and the other remedies now specified by the Consumer Insurance (Disclosure and Representations) Act 2012 and the Insurance Act 2015 are not automatically applied. The remedies available to the insurer for the assured’s unfair presentation of the risk, if available to the insurer, depend on the insurer making an election to exercise such remedies. If the insurance contract is procured by the assured’s deliberate or reckless breach of duty or if the insurer would not have entered into the insurance contract at all on any terms, but for the assured’s breach of duty, the contract is, in effect, rendered voidable.1 The innocent party2 may elect to avoid the insurance contract ab initio or to affirm it. Other than in cases of fraud or deliberate or reckless breaches of duty, the premium should be returned or at least tendered in order to put the parties back into their pre-contractual position.3 Except in cases of misrepresentation or fraudulent claims (which are considered elsewhere) or where the contract of insurance validly provides otherwise, avoidance, the right to re-write the terms of the insurance or the right to pay a proportionately reduced claim are the principal remedies available to the insurer; damages are not currently a remedy available to the insurer, although some of the remedies are compensatory in part.4. By contrast, an assured who suffers loss by reason of the insurer’s failure to pay an insurance claim within a reasonable time, that assured can claim damages for the breach of the implied term introduced by section 13A of the Insurance Act 2015.

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17.02 If the non-disclosure or, more accurately, the misrepresentation constitutes a breach of warranty, in the form of what is known as a “basis clause”, the insurance remains on foot but the insurer is discharged from liability under it. However, with effect from 6 April 2013 in respect of consumer insurance contracts and with effect from 12 August 2016 in respect of non-consumer insurance contracts, basis clauses are prohibited.5 That said, it is still permissible for specific existing-fact warranties to be agreed and to have effect.6 In that event, by section 10 of the Insurance Act 2015, the insurer has no liability under a contract of insurance in respect of any loss occurring, or attributable to something happening, after a warranty (express or implied) in the contract has been breached but before the breach has been remedied.7 Even then, the insurer’s ability to rely on the breach of warranty as a defence to an insurance claim is subject to section 11 of the 2015 Act, which provides that where there has been a breach of warranty or of any other type of contractual provision, even one whose breach depends on a pre-contractual representation being untrue, the insurer is not entitled to rely on such breach in defence of an insurance claim, where (a) the contractual term does not define the risk as a whole, (b) compliance with the contractual term would tend to reduce the risk of loss, and (c) the assured can establish that the non-compliance with the contractual term could not have increased the risk of the loss that actually occurred in the circumstances in which it occurred. 17.03 The election to affirm or to avoid or the election to re-write or not to re-write the insurance contract and/or pay or not to pay a proportionately reduced claim, in the case of a breach of the duty of good faith, does not require fresh consideration. Unlike a variation to an insurance contract, it is not a new agreement but a decision arising out of the original bargain.8 17.04 The insurer is under no obligation to avoid the insurance contract or exercise the other available remedies following a material non-disclosure or misrepresentation. There may, for example, be situations in which an insurer, with full knowledge of the assured’s unfair presentation of the risk, decides that he wishes the insurance contract to continue for commercial reasons rather than avoid the insurance contract: the identity of the assured, the insurer’s relationship with the broker, the state of the insurance market and the amount of premium (compared with the size of any claim) may all play a part in the insurer’s decision.9 Where the non-disclosure or misrepresentation becomes apparent following a claim or at the expiry of the insurance contract, the insurer’s decision may be made easier as he can assess the merits of avoidance against the premium received and his exposure to the assured. However, if the breach of duty comes to the insurer’s attention during the currency of the insurance, particularly before any claim has arisen, the insurer is faced with a more difficult decision. If the risk has become so unattractive to the insurer by virtue of the non-disclosure or misrepresentation that he wishes to be released from the contract immediately, the decision to avoid will be straightforward. This will not always be the case.

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The insurer will need to balance the prospects and likely extent of any future claims against the required return of premium. 17.05 Especially today, with the introduction of section 13A of the Insurance Act 2015, which is designed to allow assureds to claim damages in respect of losses suffered by the assured by reason of the insurer’s failure to pay insurance claims within a reasonable time, the insurer will be aware that his reasons for avoiding the insurance contract or exercising the other remedies available to it are likely to be the subject of careful scrutiny and might ultimately be tested in court or arbitration. 17.06 Bearing this in mind, the insurer will often wish to reflect on its decision for some time before making his election whether to affirm or to avoid or to exercise the other available remedies and the law recognises that an insurer is permitted time to make up his mind.10 However, it is during such time that an insurer is most at risk of affirmation and other types of election and great care should be taken to ensure that the insurance is not unintentionally affirmed or that other remedies are not exercised whilst the insurer deliberates what to do. 17.07 This chapter will consider the ways in which the insurer may lose the right to avoid the insurance contract and/or to exercise the other rights and remedies available to the insurer. Nevertheless, emphasis will be placed on the loss of the right to avoid, rather than the other remedies, because the body of authorities has developed in this respect and the availability of the remedies introduced by Consumer Insurance (Disclosure and Representations) Act 2012 and the Insurance Act 2015 have yet to be tested before the courts. In addition, the insurer’s loss of the right to rely on breaches of warranty in defence of an insurance claim will also be considered, although in so far as such defences arise by reason of basis clauses, the abolition of basis clauses will curtail the practical application of such principles.

The applicable doctrines

17.08 The doctrines with which this chapter is concerned are waiver by election and affirmation, on the one hand, and promissory estoppel,11 on the other. In view of the fact that section 34(3) of the Marine Insurance Act 1906 (which is replicated in section 10(3)(c) of the Insurance Act 2015) provides that a breach of warranty may be waived by the insurer and that when the Marine Insurance Act 1906 was enacted there was no doctrine of promissory estoppel, there is also a discussion of what waiver in the context of breach of warranty might entail.

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Unconscionability

17.09 First, we consider whether, other than by waiver (by election or by estoppel), the insurer can lose the right to avoid or any other remedy by reason of the insurer having himself acted unconscionably. Colman J in Strive Shipping Corporation v Hellenic Mutual War Risks Association (Bermuda) Ltd; The Grecia Express considered that the court must decide, taking into account equitable considerations, whether a failure on the part of the insurer to act consistently with his duty of utmost good faith “should disentitle him to avoidance of the policy.”12 17.10 However, in Drake Insurance plc v Provident Insurance plc, Moore-Bick J said that, while he felt “some unease at the prospect of an insurer’s avoiding the contract for non-disclosure in circumstances such as the present”, he did not think that “the solution is to be found in the exercise of the court’s equitable jurisdiction”.13 He gave two reasons for this: first, that, viewed as the exercise of a right of rescission, avoidance did not involve the exercise of equitable considerations since no differentiation falls to be made between rescission in equity and rescission at common law; and, secondly, that the right of avoidance and rescission “is exercisable at the election of the injured party” and “does not require the intervention of the court but is effective immediately upon the communication by the injured party of his decision to rescind the contract”.14 17.11 In a later case, Brotherton v Aseguradora Colseguros SA15 Moore-Bick J rejected the argument a second time.16 That case went on appeal, mainly on the question of the degree to which “intelligence” needs to be disclosed,17 but also on the question of whether (as Colman J had considered in The Grecia Express) the courts can impose their views on whether it is conscionable or not for a party to rescind (or avoid). Mance LJ rejected the argument, observing that “rescission under English law is not generally subject to any requirement of good faith or conscionability”.18 He said that the mere fact that a right to rescind has an equitable origin (assuming that this is the case with the right of avoidance)19 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. Mance LJ then went on to observe that, in the light of the fact that “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”,20 even if there were any scope in any circumstances for “qualifying, in effect, a clear principle recognised as long ago as 1811”,21 it could not be in a case like the one before him where the

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reinsurers did not at the time of avoidance accept or know for certain of the incorrectness of the intelligence constituting the basis of their avoidance. 17.12 It is fair to say that Mance LJ did not have regard to any particular equitable considerations nor to the need to prevent avoidance being used as an engine of oppression. Buxton LJ was even more emphatic in his rejection of the argument based on unconscionability, again without regard to these considerations. He said this:22

“The judge was right on this point, for the reasons that he gave in Drake Insurance v Provident Insurance in paragraphs 31–32. Like him, I am unable to accept the contrary view of Colman J in The Grecia Express.

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