Law of Insurance Warranties, The

Alastair Owen

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CHAPTER 12 A proposed solution

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12.1 Before discussing the solution proposed by this volume, it necessary first to consider what constitutes a merit-worthy solution. It has been demonstrated that no one approach of those adopted to date deals satisfactorily with all aspects of breaches of warranties and other conditions in commercial insurance contracts. In developing a scheme for the treatment of such breaches, this volume proposes that the approach adopted must seek to address the following criteria:

(i) Provide an equitable balance between the interests of the insured and the insurer. Any proposals for commercial insurance, like those contained in this volume, must recognise and take account of the fact that the insureds in this sphere range from sophisticated multinational corporates to the small, one man, owner operator enterprises.
(ii) Apply not only to warranties, but also to any other contractual condition that, if breached, purports to enable the insurer to avoid liability for losses under the policy.
(iii) Address breaches that occur, both prior to the policy coming on foot and those arising after the policy’s inception.
(iv) Address failures to comply with condition precedents, enabling breaches to be forgiven but only where once rectified, the risk remains substantially as contemplated by the parties.
(v) Acknowledge and take account of any prejudice suffered by the insurer.
(vi) Abolish ‘basis’ clauses.
(vii) Provide for breaches of warranties/other conditions to result, where appropriate, in tailored suspension of the insurer’s liability (with the balance of the policy remaining on risk) while the breach continues, with cover reverting once the breach has been ‘cured.’
(viii) Ensure that causal linkage plays a central role in determining liability.
(ix) Provide the courts with a degree of flexibility, such that decisions can be tailored equitably to reflect the circumstances of as wide a range of individual cases as possible. The objective should be to ensure the courts are not constrained by an overly prescriptive statutory framework, while ensuring that any regime provides a reasonable degree of predictability, clarity and certainty to all participants.
(x) Ensure that issues of the scope of cover remain a matter for agreement between the parties with which the courts should not interfere. While decisions of the court may

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legitimately clarify the scope of the policy, it is important that any reform does not erode the sanctity of scope as a matter for agreement by the parties.
(xi) Ensure that exclusion clauses are covered by the proposals.
(xii) Ensure that the proposals cannot be easily circumvented by, for example, drafting techniques.
(xiii) Heed the lessons of earlier attempts at reform of this area of the law, both at home and abroad, seeking to improve on the shortcomings of the current regimes in England and Wales, Australia and New Zealand as outlined and discussed in this volume.
(xiv) Demonstrate robustness by providing rational, equitable and consistent outcomes when ‘stress tested’ against the facts of well-known historic cases from various jurisdictions.
(xv) Address the question of whether a separate regime should be maintained for marine insurance.
(xvi) Determine the future of implied warranties.

Proposed solution

12.2 The approach proposed by this volume would apply to breaches of warranties and other terms where the contract specifies that the insurer’s remedy is avoidance of liability for losses incurred by the insured.

(i) Prior to contract coming into effect

12.3 As in New Zealand, this volume proposes that an insurer should be able to avoid liability where the insured makes pre-contractual representations that are both substantially incorrect and material.1 Under this volume’s proposals a statement would be substantially incorrect only if the difference between what was stated to be the case by the insured and what was actually correct would have been considered material by a prudent insurer.2 A statement would be material only if that statement would have influenced the judgement of a prudent insurer in fixing the premium or in determining whether he would have taken, or continued, the risk upon substantially the same terms.3 12.4 Conditions precedent and other terms requiring compliance prior to the contract’s effective date. Like the Insurance Act 2015, the solution proposed in this volume is based on the premise that, subject to the earlier provisions regarding pre-contractual representations, breaches of warranties and other relevant conditions, (being those that would, when breached, otherwise entitle the insurer to avoid liability under the policy) result in suspension of risk, rather than (in the case of warranties) automatic termination of the insurer’s liability. 12.5 The presumption in this volume is that when a term that is also a condition precedent to the attachment of risk4 is breached/not complied with, the conditionality

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applies to the whole risk and as a result the risk as a whole does not attach. The onus is on the insurer to establish that the term is a genuine condition precedent and that the parties intended it to be such. It is this volume’s presumption that, in order to ensure that the proposals cannot be easily circumvented through drafting devices, a court would wish to satisfy itself that any provision is genuinely a condition precedent: it will not be sufficient for it simply to be described as a condition precedent in the contract. If the insurer is able to demonstrate that the term was a genuine condition precedent (to the attachment of risk) and that the insured had failed to meet the requirements of the condition precedent, the insurer will not be on risk and will face no liability under the contract. It would however be open to the insured to demonstrate that the intention was that the condition precedent related only to a specific risk under the contract, rather than all risk under the contract and/or that the non-compliance having been rectified, that the resultant risk exposure was the same/essentially the same as that originally contemplated by the parties (in this latter regard, this volume’s proposals mirror section 10(5) and (6) of the Insurance Act). Where the court was persuaded that the condition precedent that had not been complied with related only to a specific risk, the contract would fail to come on risk in relation to that risk only, unless and until the breach was rectified. If the loss related to another risk under the contract, the insurer would prima facie remain liable. It may also be possible in exceptional circumstances where the CP relates to the attachment of risk generally for the insured to persuade the court that the risk remains essentially the same as originally contemplated once the non compliance is remedied. In these circumstances the risk would attach once the remedy was effected. 12.6 So for example, take the situation where a policy for the insurance of commercial premises includes a condition precedent that a particular specification of burglary alarm be installed in the premises prior to the commencement date of the policy, but the insured fails to install such an alarm by the due date. Under the proposals set out previously, if the insurer was able to demonstrate that the provision was a condition precedent, the policy would not come on risk, unless the insured was in turn able to establish that the parties’ intent was that the provision be a CP only in relation to burglary risk. Assuming the insured is able to meet this hurdle then, prior to the specified alarm being fitted, the insured would only be able to claim for a loss arising after the contract came on risk if the CP was held to be specific to burglary risk and the loss incurred related to another part of the contract. Once the alarm was fitted the contract would (assuming the risk to be substantially the same as originally contemplated) be fully on risk, including for burglary risk.

(ii) After the contract has come into effect

12.7 As with the Insurance Act 2015,5 basis clauses would be abolished under the solution advocated by this volume. This author is of the view that the provisions of s9 of

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the Insurance Act6 work well and it is proposed these would be incorporated into this volume’s solution. 12.8 Under the proposals in this volume it would be a requirement that the parties specifically agree any provisions that give the insurer the right to avoid liability, such that these be separately identified in writing, drawn to the insured’s attention and explained to him. 12.9 In these proposals the onus is on the insurer to establish a breach, whether of a warranty or other contractual provision. The proposals would apply to both risk and non-risk clauses. 12.10 As in the Insurance Act, the concept of any breach of warranty automatically discharging the insurer’s liability under the policy would be abolished. 12.11 Where a breach of warranty (or other provision enabling the insurer to avoid liability under the policy) occurs after a policy has come on risk, the breach will prima facie suspend the insurer’s liability to meet a loss until the breach is remedied. The assumption is that, where a warranty has been breached, suspension will apply to all liability under the contract except where

(i) The assured demonstrates that the provision which has not been met applies to a specific category of risk only, or to a specific location or time and that the insured’s claim relates to a different element of the contract or category of risk (or to a different location or time); and/or
(ii) Where there is no causal linkage between the breach and the loss. Again the onus will be on the insured to establish the absence of such linkage.

12.12 Where the contract specifies that breach of another contract term, not being a warranty, will result in the insurer being able to avoid liability under the policy (in part or in whole), a breach of that term will prima facie result in suspension of the insurer’s liability consistent with the terms of the right to avoid liability set out in that provision. Suspension would last until such time as the breach is remedied. 12.13 Notwithstanding the breach of a relevant contract term (whether warranty or otherwise), the Insurer will be obliged to meet the insured’s claim if:

(i) The Assured is able to establish that the provision (whether warranty or other provision) which has not been met applied to a specific category of risk only, or to a specific location or time and that his claim relates to a different element of the contract or category of risk (or to a different location or time); or
(ii) The Assured is able to establish there is no causal linkage between the breach and the loss.

12.14 Where cover has been suspended, cover will be restored when, and if, the breach is remedied. If the breach is remedied, liability will be restored from the time of rectification. As identified in the Insurance Act 2015, certain conditions (whether warranties or other provisions), such as those that require something to be done by a specific deadline are, prima facie, incapable of remedy if not met by the deadline. As in the Insurance Act, this text proposes that such conditions be treated as remedied if, when the conditionality is met, the risk remains essentially the same as that originally contemplated by the parties. This

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approach mirrors that set out in s10 (5) and (6) of the Insurance Act 2015, but, unlike in the Act, would not be confined to warranties.7 12.15 Causal linkage: this is central to the proposals set out in this volume. If a breach of a warranty or other relevant condition is continuing at the time of loss, the insurer will be able to avoid liability (in relation to that risk or the contract as a whole, depending on the nature and/or terms of the relevant provision that has been breached) by reason of that breach, unless the insured is able to establish, on a balance of probabilities, that the loss in relation to which the insured seeks to be indemnified was not caused by the insured’s breach.8 For example, suppose a policy requires that a particular specification of lock be fitted to the main door of a factory, but the insured fails to fit such a lock. Following the recommendations set out in this volume, let us suppose the court holds that the condition is a warranty, but (following successful arguments from the insured) one relating to a particular risk, burglary, and that accordingly the policy be suspended in relation to this risk until such time as the breach is rectified. Under this volume’s proposals, it would be open to the insured to argue that on the facts, the absence of the specified lock had no causal linkage with the loss as the intruders had used a JCB to smash a hole in the factory wall. This is very different from the way the Law Commission originally intended the Insurance Act 2015 to operate, although arguably not substantially different from the final wording of s11(3) of the Insurance Act.9 This text submits that experience in overseas jurisdictions shows that determining issues of causal linkage is not unduly challenging. Under this volume’s causal linkage test, subject to the court retaining flexibility in relation to proportionality (see later in this chapter), the insured would still be able to claim in circumstances where, on the balance of probabilities, he is able to show that the breach did not cause the loss incurred. Even where there is causal linkage, it is proposed the insurer would remain liable in circumstances where the action that resulted in the breach was taken to preserve life or property and/or could not reasonably have been avoided. 12.16 Proportionality will apply; accordingly if the assured were able to establish that, for example, the breach was responsible only for 40% of the loss incurred, the insurer would be obliged to meet 60% of the loss. A key element of this volume’s proposals is that in addition the court would retain the flexibility of applying a measure of proportionality in circumstances where, although the breach did not, on the facts, cause the loss, it could have done so (see example provided later in this chapter). 12.17 Prejudice: if the insurer is able to establish that he has suffered prejudice as a result of the insured’s breach, the quantum of prejudice suffered will reduce the amount for which the insurer would otherwise be liable. However, under these proposals, the insurer would need to demonstrate that it would actually have taken a different course of action and/or steps to avoid the prejudice, had it been aware of the breach, or known of the insured’s intentions: this may prove to be a high bar.

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12.18 Right of termination: in the event of a breach of warranty or other relevant condition that would enable the insurer to avoid liability, or would have done so, save for these provisions, the insurer will have the right to terminate the policy on provision of 14 days’ notice. The right of termination will however only trigger if the consequences are sufficient to justify termination under the general contract law. The right of termination ensures that the insurer is not required to take on a risk he might not otherwise have been comfortable with, enables the assured to maintain cover (by seeking cover from another party) and avoids the risk of inadvertent loss of coverage. As we have seen, the right of termination is absent from the Insurance Act 2015.10 Following a relevant breach, the insurer would have 14 days from the date at which he becomes aware of the breach to serve notice of his intent to terminate. Termination will be effective 14 days after the service of such notice. The insurer will remain liable for past losses arising from events prior to the date of the breach. The insurer will also be liable for losses under any aspect of the policy not subject to suspension, up to the point at which termination becomes effective (and for losses in relation to the suspended risk from the point at which the relevant breach is rectified until termination takes effect). The treatment of premium payments on termination is considered later in this chapter. 12.19 Scope of cover: as discussed elsewhere11 this volume believes the reference to the ‘risk as a whole’ in s11(1) of the Insurance Act 2015 to be a difficult and confusing concept. Despite the scope of the policy being a recognised legal concept, none of the relevant legislative schemes dealing with insurance warranties in England and Wales, Australia or New Zealand specifically mention the scope of cover. Under this volume’s proposals the legislative provisions would explicitly state that an insurer has no liability in any circumstances for an event or loss that is outside of the scope of the policy. Under these proposals, in any dispute over liability for loss involving a breach, or alleged breach, of a relevant condition under a policy, the proposals would require that the first issue that should be determined by the court is whether the facts fall within the scope of the policy. Of course there will be questions over whether a particular provision is a clause defining risk (scope) e.g. in determining whether the policy provides cover (only) for a building with an operational burglar alarm, or alternatively is a policy covering all standard risks for a building policy, but includes a present fact warranty where risk is excluded (via, for example, an exclusion clause) in the event that the specified alarm is not fitted or is not operational.12 It is this text’s contention that such definitional questions will always be present in contract interpretation and should not therefore be seen as particularly problematical. What is important is that the question be specifically addressed by the court as a threshold issue. In the vast majority of cases, the scope of the policy will not be in dispute. The fact that this requirement is specified under these proposals would not result in any additional burden on the courts as it is a question that should anyway be addressed. Interpretation of the intent of parties to a contract is something with which the courts are well versed.13 Explicitly addressing the issue of scope merely avoids the potential for confusion that can arise where it is not specifically referenced: for

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example see some of the cases determined under s54 of the Australian Insurance Contracts Act, as discussed in . 12.20 Exclusion clauses. The proposals in this volume would specifically apply to exclusion clauses where these purport to excuse the insurer from liability. In circumstances where the court holds that the circumstances of the loss fall within the terms of an exclusion clause (whether or not as a result of a breach of the policy terms by the insured), the insurer will have no liability for losses incurred by the insured, unless the insured is able to demonstrate that there is no causal linkage between the events that triggered the operation of the exclusion clause and the loss incurred by the insured. However, if the facts are such that the circumstances triggering the exclusion clause could have caused or contributed to the loss that occurred, the court would retain the option of applying an element of proportionality (see example next) when determining liability. In circumstances where a loss is attributable to something that occurred while the exclusion clause was in play, but where the loss does not come to light until after the exclusion clause ceases to operate, the insurer will have no liability. The fact that the loss is attributable to the breach will mean, by definition, that the insured will be unable to establish the absence of a causal linkage; proportionality would, however, apply where appropriate. 12.21 An illustration. An example will demonstrate how this volume’s proposals on both causal linkage and exclusion clauses would work. Suppose a policy covering the operation of a fleet of haulage trucks contains a provision stating that the insurer will have no liability for any loss under the contract arising from the operation of the trucks by drivers under the age of 25. For the purpose of this example, it will be assumed that the policy has been drafted in a fashion that leads the court to conclude the relevant provision is properly interpreted as being an exclusion clause, rather than an event that is outside the scope of the policy. (In accordance with these proposals, scope would be the first issue to be addressed by the court.) Suppose in this instance there is an accident and the driver was under 25, but the court concludes that the underage driver’s conduct did not, on a balance of probabilities, cause the loss that occurred. Accordingly the insurer would be liable for the loss, unless the court felt it appropriate to apply a measure of proportionality. The court would do so if it concluded that the circumstances resulting in the triggering of the exclusion clause (or breach of condition, where relevant) could have contributed to the loss. In circumstances such as this, where the driver is under 25, the risk for the insurer increases (in addition to triggering the exclusion clause); this is the prime reason that insurance policies for young, inexperienced drivers are more expensive than those for older, more experienced counterparts. As a result, this text would argue that it would be both appropriate and equitable for the court to have the flexibility to apply a measure of proportionality. The court would exercise its discretion if it felt this was appropriate, bearing in mind that, on the facts, the breach did not in fact

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contribute to the loss. We have seen that a review of insurance contract law in New Zealand has recognised the greater statistical likelihood of loss that can arise in certain circumstances (by way of example it cites the use of a vehicle for commercial purposes rather than private), even though such use may not have caused the loss in question.14 In this example it may be that in the circumstances the court feels there are credible circumstances in which having an inexperienced driver could have contributed to the loss. As we have seen, it would also be open to the insurer to argue that it has suffered prejudice, at least to the extent of the premium that would have been charged for a driver aged under 25.15 This text argues that an approach on the lines set out gives the court greater flexibility equitably to balance the interests of the insured and insurer, albeit arguably at the cost of some loss of certainty. It is this author’s position that it surely cannot be acceptable for an insurer to be obliged (where on the facts there is no causal linkage) to meet the full measure of a claim where the insured has flagrantly and without any mitigating circumstances, breached a policy condition and increased the risk. The approach in this volume provides the court with the flexibility it needs to deliver an equitable outcome.

Implied warranties: is a separate regime necessary for marine insurance?

12.22 This author argues that the proposals set out in this volume should apply to all forms of commercial insurance including marine insurance. The existing regime of implied warranties was left untouched under the Law Commission’s proposals. As we have seen, ss10(2) and 11(1) of the Insurance Act 2015 make it explicitly clear that ss10 and 11 apply to the implied warranties identified in the Marine Insurance Act 1906.16 This author believes this to be a flawed approach and that ideally the implied warranty of seaworthiness should be abolished on the grounds that, inter alia, it is of little relevance in the modern world.17 Instead it should be open to parties to make what provisions they felt appropriate for seaworthiness through express terms. Alternatively, if such abolition is viewed as too radical, then as a minimum, this author believes that the existing provisions relating to implied warranties should be amended such that the insurer would only be able to escape liability in circumstances where the insured had knowledge of the unseaworthy condition of the vessel and failed to take such steps as were reasonably available to render the vessel seaworthy. Even then the insurer would remain liable if the breach was remedied by the time of loss and/or if the insured were able to establish the absence of any causal linkage between the breach and loss. If abolition was rejected such amendments would significantly reduce the impact of the implied warranty and ensure that it more equitably reflected the interests of the insured. However, if this alternate approach was to be adopted then, in order to ensure that this did not result in tilting of the playing field too far in the favour of the insured, this

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volume recommends that the amended implied seaworthy warranty should be a continuing warranty (rather than one that is only applicable at the commencement of the voyage), such that in circumstances where the insured becomes aware of a development during a voyage that renders the vessel unseaworthy and failed to take such steps as were reasonably available to render the vessel seaworthy, the insurer would have no liability. This reflects the approach discussed by the ALRC in ALRC 91.18 In the words of the ALRC, this

better recognises that with modern communications and technology an insured shipowner or management company may have knowledge of unseaworthiness that has arisen in the course of a voyage and may be in a position to take steps to remedy the deficiency.19

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