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'I Honestly Have No Idea': Good Faith and Insurance Contracts

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About The Author

Rowan Clapp (Former Public Law & Human Rights Editor)

Rowan graduated from Durham University in 2013 with a First Class degree in Philosophy and Theology. He completed the GDL at BPP University on a Lord Haldane Scholarship and Hardwicke Entrance Award from Lincoln’s Inn. He is currently undertaking an LLM at University College London and working as a volunteer caseworker at Reprieve.

Image © Jake Rust

Insurance law. Not an area that immediately invites attention from thrill seekers. And what am I as a young lawyer, if not a thrill seeker?

You are unlikely to come across cannibalism (my next article), snails in ginger beer, or threats to the life of the nation in discussing insurance contracts. However, as I have been telling everyone during the preparation of this article ‘it’s actually really interesting’ - particularly with regard to good faith. This concept is surprisingly absent in general UK contract law, but is of special importance for insurance. It is therefore noteworthy at least to the extent that it is unusual. However, as I now explain, the development of good faith reveals much about the fundamental nature of the insurance contract, and the way that it has changed in the last 109 years.

In this article I first give a brief overview of the development of good faith (which for the purposes of this article I conflate with ‘Utmost Good Faith’ and abbreviate to UGF). I briefly indicate why it is an important concept for insurance contracts before indicating the deficiencies that largely stem from sections 17 to 20 of the Marine Insurance Act. Of particularly grave importance, and in reference to the bizarre title of this article, is the possibility of an assured’s innocent breach of an onerous duty to understand and provide to the insurer all that he would want to know about the facts of the risk.

I indicate several statutory ways in which these problems have been met with regard to both business and consumer insurance. I close by suggesting that rumours of good faith’s death have been grossly exaggerated. The role of good faith seems unclear for the future, but against the odds, it has survived recent reform.

The History of Good Faith

Good faith, being a duty of general application, has no clear origin. However, as it is understood by modern contract lawyers, Lord Mansfield went some way to creating the doctrine in the seminal case of Carter v Boehm (3 Burr 1905) in 1766.

The risk in Carter was described by Rix J as the ‘archetypal political risk’ at the president’s lunch at British Insurance Law Association (BILA) in December 2001. It involved the insurance of Fort Marlborough, an Indian trading settlement on the island of Sumatra. Mr. Carter was the governor of the Fort and had taken out insurance against the fort’s capture by a foreign enemy.

When the fort fell to the French, Mr. Carter approached Mr. Boehm to make a claim. However, the underwriter sought to avoid liability on the basis that he had not been made aware of the fort’s vulnerability to a potential attack. Lord Mansfeild rejected this defence. Mr. Boehm was well aware of the assured’s anxiety over an impending attack, this was the reason for the insurance in the first place. That much seems obvious.

Lord Mansfield’s judgement focused on the inequities in the contractual relationship occasioned by possibility of misrepresentation and/or non-disclosure by one of the parties. In particular, he emphasised that insurance contracts were peculiarly susceptible to such imbalances, noting of:

[t]he 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 within his knowledge to mislead […] that the circumstance does not exist, and induce him to estimate the risk, as if it did not exist

With one eye on when this decision was reached, an age of steam power, colonialism and socially acceptable moustaches, it is particularly easy to agree with the remarkably prescient Lord Mansfield for several reasons.

In a rapidly expanding world, insurers would be pragmatically limited if it were in their hands to investigate every aspect of the risk that they were insuring. Without telephones or the Internet, this task would be practically impossible. Utmost good faith (UGF) compels the assured to assume some of this workload by abstaining from misrepresenting the truth of his situation, and by disclosing all facts material to the insurer.

Lord Mansfield had intended that the duty of UGF would be applied to all contracts. However, as Lord Falconer, the then Lord Chancellor stressed in the annual COMBAR lecture, the clarity and precision of English contract law is revered around the world. This clarity, he emphasises, is derived from the absence of any general duty of good faith in English contracts. It is obvious then, that Lord Mansfield’s edict did not extend to contract law more generally.

But good faith has become increasingly important in contracts of insurance. There are many factors about insurance that makes UGF an important duty. Perhaps the most obvious is the remarkable imbalance present in insurance contracts. Obviously there is imbalance in all contracts, this is how deals, bargains and profits are made. However, in insurance, the imbalance is especially pronounced, and as such ‘there is no class of documents as to which the strictest good faith is more rigidly required in courts of law than policies of assurance’. This is because as Scrutton LJ notes at paragraph 102 in Rozanes v Bowen, ‘the underwriters know nothing and the assured knows everything’. The duty of UGF is necessary, then, because in insurance contracts, all facts relevant to the calculation of insurance are known to the assured.

The insurer depends entirely on how facts are presented to him in calculating the terms, duration and premium of the insurance offered to the assured. This is also true at the claims stage, where the assured is in possession of all relevant factors, whilst the insurer is not even aware of the claim until it is made! As such, Alison Padfield notes in her book Insurance Claims that:

the inequalities of knowledge between insured and underwriter led, in insurance law, 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 what is essentially a speculative agreement which he would otherwise be unable fairly to assess

Good Faith, Bad Statute?

Lord Mansfield’s comments in Carter eventually led to a statutory basis for UGF in the Marine Insurance Act 1906 (MIA). Jessel MR affirms in London Assurance v Mansel, the duty imposed by the MIA ‘is required in all cases’ of insurance and is not confined to the marine form only. Section 17 of MIA holds that:

[a] contract of marine insurance is a contract based on the UGF, and if the UGF be not observed by either party, the contract may be avoided by the other party

The principle of UGF is amplified by several further duties under sections 18, 19 and 20 of the Act. These place specific emphasis on the pre-contractual duties of the assured to disclose facts material to the risk (non-disclosure), and to abstain from making false statements when negotiating the contract (misrepresentation). This is all well and good, that there is an imbalance in the contractual position that the law seeks to rectify. However as I will now explain, the duties imposed by the MIA are burdensome on the assured and the remedies available favour the insurer.

In essence, as Merkin et al explain in the seminal Arnould textbook, s 18(1) MIA prohibits the ‘suppression of or neglect to communicate a material fact’ relating to the contract of insurance. Failure to do so will result in avoidance of the contract ab initio, confirmed in the judgment of Hirst J in Litision Pride. Clarke explains that this will allow avoidance of the contract ‘as if the insurer had not agreed to the contract at all’ in his similarly authoritative Law of Insurance Contracts.

Section 20(1) compels the assured to be truthful in any representations made to the insurer.

The first problem with these duties is the problem of innocent breach of duty. It is the responsibility of the assured to provide all the information that is material. Material information will be that which would have affected the ‘prudent insurer’ in assessing the risk.

But how is the assured supposed to know every fact that an insurer will want to know in assessing risk? Unless he is an insurer or an insurance lawyer he will have no idea what he is talking about. Crucially, he will be in this position completely honestly. Without seeking to mislead or dupe an insurer he may supply slightly deficient information to the insurer, leaving him in breach of duty.

In an attempt to avoid doing so, the assured may volunteer all information he knows about the risk. This will lead to whatever is material being hidden in a large pile of irrelevancies.

The cumulative affect of this problem seems to be a stressed out assured and an insurer with a lot of paperwork to do. Not so bad. However, it is only when the remedy for a breach of UGF is revealed that true problems emerge.

The duties of disclosure and non-misrepresentation are designed to balance the apparently ‘asymmetry of knowledge’ inherent in insurance contracts. However, they in fact create a far more damaging imbalance of duties when coupled with the draconian remedy of avoidance ab initio.

Following the decision of Staughton LJ in Kauser v Eagle Star, the remedy of avoidance will be available when the assured has not been dishonest in failing to disclose a material factor. What this means is that an assured might find himself in a position where he seeks to claim under his policy, but his insurer will escape liability. Controversially the insurer can escape liability if he can provide a factor that might have affected the insurance contract that the assured did not bring up when he made the contract. The assured will protest, but in vain.  The insurers will all be in the pub celebrating. Eggers, probably the most prominent commentator on insurance contracts has referred to this as ‘overkill’, and it is easy to see why.  

Another problem with the remedy of avoidance is noted by Padfield. She identifies few situations in which the assured will want to rely on the remedy. Good point. Why would an assured person want to avoid the insurance on the discovery of an absence of good faith by his insurer? Yes, he or she may reclaim some of the money paid for the insurance. But then he will also be left with no insurance cover for the period originally contracted. And this was the whole point of taking out insurance in the first place! Certainly, in The Star Sea Lord Hobhouse (along with everyone else who is not an insurer) recognised that the remedy is ‘one sided’.

So UGF leaves the assured without cover if the insurer discovers that a material fact has not been disclosed. This is possible even when the assured has been entirely honest in the preparation of the insurance policy. Further, there are few, if any, circumstances in which the assured will want to avoid the contract. The duty, apparently intended to rectify the initial imbalance in the pre-contractual position of parties to contracts of insurance seems to achieve quite the opposite. Christopher Butcher, of 7KBW explains:

These developments have led to the paradox that the application of the rules […] have placed in the hands of insurers a weapon which may be wielded in a way which produces a result which is the opposite of […] what good faith would demand

CIDRA & IA

Relatively recent statutory developments have attempted to address the imbalances that I have highlighted above. Less helpfully, the Marine Insurance Act has been in operation for 109 years. A brief study of these cases betrays an unhelpful lack of clarity as to the timing and extent of the duty of UGF. The Law Commission has attempted to rectify this situation, predominantly through two insurance acts, one for consumers, the other for business contracts.

The effect of the Consumer Insurance (Disclosure and Representations) Act 2012 (CIDRA) is to temper the remedy of avoidance and to impose less imposing duties on contracts of consumer insurance.

The Act replaces the consumer’s duty to volunteer what is material with a duty to take reasonable care not to make pre-contractual misrepresentations. The duties of ss 18-20 MIA are replaced by the duty to take reasonable care not to misrepresent to the insurer as a result of s 2(2) and s 2(4) CIDRA. Therefore, the thrust of the act is that:

[i]t should be for the insurer to ask about what it wants to know, rather than the emphasis being on the insured to volunteer that which is material

This goes some way to meeting the problem of innocent misrepresentation raised earlier. The assured will no longer be compelled to release all the information he knows in panic that some of that information is deemed material by the ‘prudent insurer’.

The rules under CIDRA also preclude an insurer from exploiting the assured’s failure to disclose. The insurer is in charge of delineating those facts that are material. This seems reasonable – the assured is no longer in a position where he honestly has no idea what he is talking about, at least in regard to his insurance policies.

CIDRA also tackles avoidance in a sympathetic manner. Where a misrepresentation is honest and reasonable, an insurer will still be obliged to pay the claim. But where the misrepresentation was reckless or deliberate, then the Act permits avoidance under sch 1 para 2(a) as a cumulative affect of either s 5(1)(a) and s 5(1)(b) and s 4(2).

Where the insurer would have entered the contract, but on different terms, where they are unknowingly concealed by the assured, then under sch 1 para 6 those terms will be included in the contract. Where the insurer would have entered the contract but charged a lower premium then the insurer will be allowed to proportionately reduce the amount paid for the claim under sch 1 para 7.

This seems like a much more reasonable and subtle position to be in. The consumer is not burdened by having to guess which facts will be material, and the structure of remedies available for a breach of UGF is less austere.

This goes some way to addressing the problems arising from UGF as it appears in sections 17-20 MIA, but for consumers only. The Insurance Act 2015 received royal assent on 12th February 2015. Amongst other things, it has the aim of meeting problems caused by the all or nothing remedy of avoidance in contracts of business insurance. This is especially obvious; on a reading of s 14(1) of the Act stipulates that:

[a]ny rule of law permitting a party to a contract of insurance to avoid the contract on the ground that the utmost good faith has not been observed by the other party is abolished

This secures a more useful remedy for the assured. Crucially, the Act allows for damages to be afforded in instances of breach. Implicitly, this has been what everyone wanted the entire time. The court will now be allowed to assess the gravity of the indiscretion of the defendant party and to place the claimant in the correct position. Like CIDRA, however, avoidance will be available when the assured has been careless, deliberate or reckless in contracting. As explained above, and for obvious reasons, this makes sense.

Under the Act, sections 18-20 MIA are repealed and replaced by a duty called ‘fair presentation’. This duty boils down to a duty to disclose and a duty not to misrepresent the material. But this will be judged on the basis of what is reasonable, so there is not imposition as onerous as in 1906.

It seems that reform has a relatively happy ending: the tyrannical reign of the remedy of avoidance is significantly limited, and the assured is compelled to behave as a reasonably reasonable insured person. This seems fair. Insurers certainly think so. As James Dalton, Director General of the ABI recognises, ‘we welcome the modernization and rationalization of insurance contract Law’. John Hurrell has also agreed that ‘the provisions of the new Insurance Act bring this country’s insurance contract law for commercial insurance right up to date and fit for the modern world’. DAC Beachcroft confirms my explanation, noting of the successes obtained by the Act: ‘the remedies are no longer ‘one size fits all’ but instead proportionate’.

Closing Remarks: Good Faith Prevails.

With UGF seemingly neutralised by the cumulative effects of CIDRA and IA, it makes a ‘Miracle at Medinah’ style comeback. Good faith endures as an ‘interpretative principle.’ The Act is so young that it is hard to know exactly what this will mean. What we do know on the basis of CIDRA and IA is that avoidance and innocent misrepresentation is over. This is a good position for modern insurance law. Who knows what havoc the enduring duty of s 17 MIA will have on the future of insurance? Only time will tell.

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Tagged: Banking & Finance, Commercial Law

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