A Critical Assessment of the Requirement of Utmost Good Faith in Marine Insurance Contracts - Essay Example

?A Critical Assessment of the Requirement of Utmost Good Faith in Marine Insurance Contracts By The doctrine of utmost good faith (uberrimae fidei) as opposed to mere good faith (bonae fidei) emerged as a creature of the common law during the 18th century. Despite criticism, the doctrine survived and continues some 200 years later, having been codified by statute in the meantime.1 The significance of this duty is that the remedy for breach of the duty is that the contract can be avoided.2 Most of the criticism of the duty of utmost good faith surrounds that fact that the duty is breached regardless of whether the breach is intentional, innocent, reckless or negligent or tied to any actual losses. This can produce unfair consequences particularly for the insured.3 This research study critically assesses the doctrine of utmost good faith in marine insurance contracts by tracing its origins and the developments that followed. The idea is to determine the rationale for the duty of utmost good faith and how the current law can be reformed to take account of the need for the duty and to safeguard against the harsh consequences for a breach of the duty. Table of Contents Abstract…………………………………………………………………………………….2 Introduction………………………………………………………………………………...4 I. Origins of the Duty of Utmost Good Faith…………………………………………5 II. Developments of the Duty of Good Faith………………………………………….11 III. Recommendations for Reform of the Doctrine of Utmost Good Faith ……………14 Conclusion………………………………………………………………………………….18 Bibliography………………………………………………………………………………..20 Introduction Insurance contracts in general represent a special class of contracts since they are bound by the uberrimae fedei doctrine. As a result all contracting parties have a duty to ensure that they do not misrepresent crucial facts and are likewise under a persistent duty to disclose all facts that might induce insurers to assume the risk.4 Understandably, the duty of utmost good faith was necessary during the 18th century. However, in a world with modern technological methods of obtaining and sharing information, the duty of utmost good faith, particularly the duty to disclose all material information appears to be a bit harsh.5 More troubling perhaps is the fact that a failure to disclose material facts, regardless of the absence of fraud or specific intent renders the contract voidable ab initio. As such the result can be entirely disproportionate and unduly harsh. However, it is accepted that the insurers not only underwrite risks but assess them based on the facts known to them at the time of underwriting the risk. It therefore follows that information solely in the possession of the insured is crucial for this purpose.6 This research study provides a critical assessment of the duty of utmost good faith in marine insurance contracts with a view to determining the rationale for the duty and whether or not the duty can and should be reformed. The main issue is whether or not reforms can equitably address the harsh consequences and to ensure that the duty to disclose corresponds with the realities of the relationship between the insured and the insurer and the current state of modern technology. This paper is therefore divided into three parts. The first part of the paper examines the origins of the duty of utmost good faith in the common law. The second part of the paper examines the developments of the duty of utmost good faith and the final part of the paper analyses possible reforms that can effectively create more balance between the insured and the insurer having regard to the purpose of the doctrine of utmost good faith and modern technological advances. I. Origins of the Duty of Utmost Good Faith The duty of utmost good faith was introduced into the common law relative to a marine insurance contract by Lord Mansfield in Carter v Boehm during the Seven Years War.7 During the war, George Carter, the Governor of Sumatra took out an insurance policy on Fort Marlborough to cover the risk of an attack by the French. In 1760, the fort was attacked by the French and the Governor attempted to recover damages under the insurance policy. The underwriter denied the claim alleging that the Governor failed to disclose the fact that the fort was not strong and was indeed vulnerable to attack. Although the underwriter failed, Lord Mansfield formulated the duty of utmost good faith. Lord Mansfield stated that: The 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 in his knowledge, mislead the underwriter into a belief that the circumstance does not exist, and to induce him to estimate the risque, as if it did not exist.8 Lord Mansfield went on to state that withholding that kind of information is fraudulent and renders the policy void. Even if that information is withheld mistakenly and in the absence of fraud, the underwriter is misled nonetheless and as a result the “policy is void” because the actual risk is distinguished from the “risque understood and intended” when the agreement to underwrite takes place.9 Good faith therefore operates to forbid: Either party by concealing what he privately knows, to draw the other into a bargain, from his ignorance of that fact, and his believing the contrary.10 Lord Mansfield’s good faith doctrine therefore assumes that the insurance contract is a special class of contract conferring upon the parties a “positive duty to disclose”.11 The rationale is that the parties’ knowledge of the pertinent facts is uneven. However, as a rationale this fails as there are any number of situations outside of insurance policies where the parties’ knowledge of pertinent facts is uneven. The rationale however, must be examined in the cases that followed Carter. The emerging principle was that there were limitations on the doctrine of good faith, in that the insure must not merely sit by and become a passive receptor or pertinent facts. This may be the only means by which to distinguish insurance contracts from other contracts as the insurer is a professional with the means to investigate circumstances and facts. For instance in Carter Lord Mansfield rationalized that the insurer must have known or could have known that the Governor insured the fort because there was a likelihood of it being attacked. By merely underwriting the fort, the insurer must have understood that an attack was possible.12 A similar limitation on the duty to disclose was asserted in Noble v Kennoway insured’s ship arrived at a port in Labrador and was taken for a fishing expedition before it was unloaded. During the fishing expedition, privateers took the ship and the owners attempted to claim the value of the cargo under an insurance policy. It was argued on behalf of the insurer that liability could not be founded since the ship’s unloading had been delayed. The insured submitted that it was trade practice that unloading was delayed at the port because it lacked the requisite ware house facilities. Lord Mansfield held that underwriters ought to know the trade practices or at the very least acquaint themselves with trade practices.13 In Mayne v Walter the insured attempted to claim against an insurance policy when his ship was seized by a French ship under an ordinance prohibiting Dutch ships transporting cargo for any country involved in the war against France. Lord Mansfield ruled than in cases where neither party was aware of pertinent information the underwriter “must run all risks: and if the underwriter knew of such an edict, it was his duty to inquire, if such a supercargo was on board.”14 It is thus clear that according to the duty of good faith as formulated by Lord Mansfield, the underwriter could not merely sit back and accept information supplied to him/her by the insured. The underwriter clearly had a duty to perform a proactive duty of investigation. The duty was further explained in Friere v Woodhouse by Borrough J, who ruled that: What is exclusively known to the assured ought to be communicated; but what the underwriter, by fair inquiry and due diligence, may learn from ordinary sources of information need not be disclosed.15 However, developments in subsequent cases would alter the scope of Lord Mansfield concept of good faith, removing limitations to such an extent that the insurer evolved into no more than a passive receptor of information. For example in Bates v Hewitt [1867] 2 LRQB 595 the court held that the claimant’s failure to disclose the well-known fact that the Georgia vessel was a Confederate vessel was a breach of the duty of good faith. In fact, the underwriter admitted to knowing of the vessel’s identification but that it had not been on his mind at the time of underwriting the insurance for the claimant. In determining that the insured had breached the duty of good faith, Lord Cockburn ruled that the insured: Is bound to communicate to the usurer all matters which will enable him to determine the extent of the risk against which he undertakes to guarantee the assured.16 Further eroding the doctrinal basis of the duty of good faith as enunciated by Lord Mansfield, it was also held that, even where the facts were discoverable by the insurer, there was no duty to investigate or confirm those facts.17 Taking the doctrine of good faith a bit farther, Lord President Inglis introduced the term utmost good faith in Life Association of Scotland v Foster. In this case, Lord President Inglis stated that: Contracts of insurance are in this, among other particulars, exceptional, in that they require on both sides uberrima fides. Hence, without fraudulent intent, and even bona fides, the insured may fail in the duty of disclosure.18 Blackburn J developed the prudent insurer test in Ionides v Pender [which attempts to rationalize the duty of good faith and at the same time temper its uneven bias in fabour of the insured. Even so, the prevailing view that the insurer was merely a passive receptor of information remained evident in Blackburn J.’s ruling. Blackburn J ruled that while it may be a bit much to expect the insured to disclose all possible facts that might bear on an insured in determining whether or not to underwrite a risk, the insured was nevertheless duty bound not to conceal “a material fact” and such concealment “though made without any fraudulent intention, vitiates the policy.”19 Blackburn J expounded further in Brownlie v Campbell when he stated: In policies of insurance, whether marine insurance or life insurance, there is an understanding that the contract is uberrima fides, that if you know any circumstances at all that may influence the underwriter’s opinion as to the risk he is incurring, and consequently as to whether he will take it, or what premium he will charge if he does take it, you will state what you know. There is an obligation there to disclose what you know; and the concealment of a material circumstance known to you, whether you though it material or not, avoids the policy.20 Thus the development of the duty of good faith by Lord Mansfield evolved into Blackburn J’s absolute duty of utmost good faith which was followed by the codification of the Marine Insurance Act 1906. Two sections of the 1906 Act are of particular significance. Section 17 of the 1906 Act characterizes the marine insurance contract as a one that is “based upon the utmost good faith” and failure to observe this duty will render the contract voidable by either party to the contract.21 Section 18(1) is even more instructive and provides that: …the assure must disclose to the insurer, before the contract is concluded every material circumstances which is known to the assured, and the assured is deemed to know every circumstance which, in the ordinary course of business, ought to be known by him…22 Section 18(2) goes on to proclaim that all circumstances are material if they are such that they “would influence the judgment of a prudent insurer” in underwriting the risk.23 Some semblance of Lord Mansfield’s original doctrine of good faith is captured by Section 18(3) of the 1906 Act. In this regard, Section 18(3) provides that where an insurer fails to investigate, some circumstances need not be disclosed. These include, that which “diminishes the risk”; 24 or anything that the insure knows or ought to know.25 In this regard, the insurer “is presumed to know matters of common notoriety or knowledge” as well as those things that are ordinarily expected in the “course of his business”.26 The Marine Insurance Act 1906 obviously did not intend to abandon the duty of good faith as formulated by Lord Mansfield as evidenced by Section 18(3) of the Act. However, since Section 18 (3) is prefaced by Section 17 which consciously adopts the latter cases’ doctrine of utmost good faith, it can be assumed that the emphasis is therefore on the duty of utmost good faith. The limitations placed on the duty as enunciated by Lord Mansfield and the cases that followed are therefore secondary to the virtually unrestricted duty of utmost good faith. II. The Developments of the Duty of Utmost Good Faith When the 1906 Act was first considered in Joel v Law Union and Crown Company in 1908, Moulton LJ introduced a reasonableness test. Moulton LJ stated that in addition to insured’s duty to act “honestly and frankly,” the insured must act in a manner that the reasonable man would in determining what was material disclosure. Moulton LJ explained that: This further duty is analogous to a duty to do an act which you undertake with reasonable care and skill, a failure to do which amounts to negligence, which is not atoned for by any amount of honesty or good intention. The disclosure must be of all you ought to have realized to be material not of that only which you did in fact realize to be so.27 It therefore follows that the insured is under an onerous duty to disclose all material facts, whether or not the insured is aware of its significance. This can lead to unfair and unjust outcomes. The unfair nature of this mandate is reflected in the case of Becker v Marshall where the plaintiff had failed to disclose the fact that he was a foreigner and had changed his name. Salter J held although plaintiff’s failure to disclose was not intentional, “the average business man, the average reasonable man, would not have taken that view” and such a person would “have disclosed and would have known that it was necessary to disclose.”28 In more recent times however, the judiciary have taken issue with the unjust and harsh consequences of the duty of utmost good faith as expressed in the Marine Insurance Act 1906 and interpreted by the courts. For instance in Anglo-African Merchants Ltd. v Bayley Megaw J. questioned the fairness of requiring the insured to disclose even those facts that he/she does not realize or know to be material.29 In Lambert v Co-operative Insurance Society, Ltd. the Court of Appeal criticised the previously formulated prudent insurer test and called upon Parliament to revise the duty of utmost good faith so as to restore a degree of fairness.30 Further criticism of the doctrine of utmost good faith was made by Ford J. in Reynolds and Anderson v Phoenix Assurance Co. Ltd. In this case Ford J noted that the duty of utmost good faith as it stands requires that an insured is only under a duty to disclose false allegations of dishonesty and no duty to disclose actual dishonesty claims made against him/her. Ford J. specifically states that: The only occasion on which the allegation as an allegation must be disclosed is when it is not true. This appears to me to be a conclusion so devoid of any merit that I do not consider that a responsible insurer would adopt it and nor do I.31 The point was taken up more recently in Strive Shipping Corp. v Hellenci Mutual War Risks Association (Bermuda) Ltd. It was held in this case that if a charge of criminal conduct is pending, and that charge would have some influence on the decision to insure the claimant, even if the charge is “unfounded cannot divest the circumstances of the allegation of the attribute of materiality.”32 The position was reflected by Colman J. in North Star Shipping Ltd. v Sphere Drake Insurance Plc. Although in this case Colman J. agreed with the observations of Fords J, but felt bound by precedent and the 1906 Act.33 The judgment of Slaughter J in Kausar v Eagle Star Insurance Co. Ltd exposes perhaps the greatest injustice attached to the duty of utmost good faith in contracts of marine insurance. This injustice relates to the remedy which is ultimately avoidance of the insurance contract. As Slaughter J. noted: Avoidance for non-disclosure is a drastic remedy. It enables the insurer to disclaim liability after, and not before, he has discovered that the risk turns out to be a bad one; it leaves the insured without the protection which he thought he had contracted and paid for.34 In this regard there ought to be some restraints, or at the very least a greater degree of restraints on the duty to disclose. The insurer is granted far too much room to renege on a policy in circumstances where it would be entirely unjust and unfair to do so. So far, the law assumes that the insured ought to know even where unrelated facts might influence the judgment of the insurer. For instance, the fact that there are unresolved, yet unfounded allegations of criminal conduct or the mere fact that the insured is a foreigner and had previously had a name change appears to have very little if anything to do with the risk. In the information age where information is readily assessable, these stringent disclosure requirements appear to be even more Draconian than the requirements set forth by Lord Mansfield 200 years ago. The obvious outcome is the disproportionate justice that highly favours the insurer and ultimately leaves the insured vulnerable to not only lose the protection purchased, but the premiums paid in anticipation of that protection. While it is certainly important to ensure that the insured does not obtain insurance protection by virtue or fraud or when he/she is a high risk for insurance protection, a more judicious line needs to be drawn. III. Recommendations for Reform of the Doctrine of Utmost Good Faith There have been attempts to reform the duty of utmost good faith but no reforms have been made despite judicial expression of unease with the doctrine.35 This remains one of the most puzzling developments in the long chain of the evolution and development of the doctrine of utmost good faith itself. The National Consumer Council 1997 produced a report, Insurance Law Reform: The Consumer Case for a Review of Insurance Law which makes reasonable recommendations that insert some degree of fairness in the currently disproportionate state of the duty of utmost good faith. The National Consumer Council’s report which was prepared by John Birds in 1997 recommended that the duty to disclose ought to be confined to information that the insured is aware of and knows will bear upon the insurer’s judgment or at the very least, that a reasonable individual ought to know is important to the insurer’s judgment.36 These recommendations never came to fruition. Even so, the British Insurance Law Association set up a committee in 2001 aimed at making recommendations for reform to the Law Commission for the purpose of drafting an Insurance Contracts act. The resulting report, Insurance Contract Law Reform 2002, mimicked the recommendations reflected in Birds’ 1997 report.37 The courts have taken up the challenge as well. In Pan Atl. Ins. Co. Ltd. v Pine Top Ins. Col Ltd. the House of Lords interpreted the material misrepresentation within the meaning of the Marine Insurance Act 1906 as follows: I conclude that there is to be implied in the Act of 1906 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 contract (per Lord Mustill).38 The point is, the judges are even minded to be become active in interpreting the 1906 Marine Insurance Act in such a way as to diminish the harsh consequences of the duty of utmost good faith. The obvious implication is that the time for modifying the law and removing or at the very least providing a greater degree of fairness is long overdue. In Assicurazioni Generali SpA. V Arab Ins. Group the Court of Appeal went further in modifying the law by requiring that the insurer prove to the satisfaction of the court that the insurer was actually induced by the undisclosed fact or the misrepresentation to underwrite the insurance policy, although it may not be the only influential factor.39 Despite these efforts by the judiciary, they can only do so much to reform the law as they are bound by the Marine Insurance Act 1906 which essentially reflects the unsatisfactory state of the law that existed over the last 200 years. The recommendations offered by Birds 1997 and the Insurance Contract Law Reform 2002 appear to be the best solution. The insure should only be bound to disclose those facts that are in his or her own knowledge and that he/she deems to be relevant to the insurance policy or the insurer’s judgment relative to assuming the risk. The position taken by Slade LJ in Banque Keyser Ullman S.A. v Skandia (UK) Insurance (C.A.) is also instructive and should be codified by the legislators. According to Slade LJ the duty to disclose on the part of the insurer ought to: Extend to disclosing facts known to him which are material either to the nature of the risk sought to be covered or the recoverability of a claim under the policy which a prudent insured would take into account in deciding whether to place the risk for which he seeks cover with that insurer.40 The fact is the only remedy accorded the insured is no remedy at all and it comes at a time when the insurer is in the greatest need of the benefit of that insurance protection. The remedy is avoidance and it comes after that insured is seeking to cash in on his insurance policy. At this point the loss has already been sustained and it therefore appears to be unduly harsh to permit the loss of protection so loosely in such circumstances. It is conceivable that the insurer may also seek to avoid compensating the insured. The law however, appears to take the position that only the insured might seek to obtain an advantage in the negotiating of an insurance policy. Little regard, if any is given to the possibility that the insurer might seek to gain an advantage when the time comes to compensate the insured. This is perhaps what guided Colman J. to suggest in Strive Shipping Corp. v Hellenci Mutual War Risks Association (Bermuda) Ltd that the insured’s right to avoid is subject to the “duty of the utmost good faith”.41 Therefore the duty of utmost good faith should also be interpreted to equally apply to both the insured and the insurer. As it is now, the duty of good utmost good faith appears to be centred primarily on the insured with little regard to the fact that the insurer may be just as inclined to mislead or deceive the insured. It is unfortunate that the law seeks to facilitate the insurer who might very well be inclined to deliberately and without just cause avoid an insurance claim. It is understandable therefore that the courts have in more recent times insisted that the insurer not act in bad faith in seeking to avoid an insurance claim.42 However, as previously noted the courts can only refine and add to the law, but they may not change it as it is. Therefore affirmative action should be taken by the courts to correct the disproportionality of the duty of utmost good faith in the law of marine insurance contracts. In addition to modifying the duty to disclose, so that the insured is only under duty to disclose facts that he or she is aware of and can reasonably expect to know will influence the insurer’s decision to underwrite the insurance, the duty of utmost good faith should be modified further. The duty of utmost good faith should also require that the misrepresentation or the failure to disclose be related to the actual risk. Failing these caveats, the insurer should be bound by the insurance policy and should not be permitted to avoid the policy altogether. In circumstances where the non-disclosure or misrepresentation comes to light prior to the insured’s attempt to make a claim, the right to avoid the contract altogether should also be modified. If the non-disclosure or misrepresentation only impacts the value of the claim, the insurer should merely adjust the claim to reflect the value of the policy having regard to the newly discovered and previously undisclosed or misrepresented information. Completely avoiding the policy appears to be unduly harsh particularly where the insured is innocent or mistaken. Conclusion The duty of utmost good faith or uberrimae fidei sets an unrealistic high standard on the insured and functions to liberate the insurer to such an extent that insurance claims can be avoided for the slightest misstep on the part of the insured. The duty of utmost good faith, although 200 years old, has evolved about as far as the courts can take it. It is obvious that over the last 10 years of so, the courts have taken as much latitude as the separation of powers will allow to modify the existing doctrine so as to minimize the harsh results. However, the courts are bound by the implementation of the Marine Insurance Act 1906 which is perhaps the most likely reason for the perpetuation of the unjust functioning of the duty of utmost good faith. Unless and until Parliament takes the initiative and reforms or amends the existing legislation, there is always a danger that the courts will revert to the draconian interpretation of the 1906 Act and call upon insurers to impose all that he/she knows or should know regardless of how important it might be to the insurer’s decision to underwrite the insurance policy. As it is the duty of utmost good faith imposes upon the insured an impossible duty of disclosure. Fortunately, the courts have modified that approach to some extent. However, unless and until Parliament takes the initiative and changes the current law, the duty of utmost good faith will remain a threat to the balancing of the insured’s reasonable expectations and the unreasonable protection of the insured. Bibliography Textbooks Stempel, J. Stempel on Insurance Contracts, (US: Aspen Publishers, 2007). Articles/Journals Birds, J. “Insurance Law Reform: the Consumer Case for a Review of Insurance Law”. National Consumer Council, 1997. British Insurance Law Association. ‘Insurance Contract Law Reform,’ September 2002. Lowry, J. ‘Redrawing the Parameters of Good Faith in Insurance Contracts.’ (2007) 60(1) Current Legal Problems, 338-384. Lowry, J. ‘Whither the Duty of Good Faith in UK Insurance Contracts.’ (2009) 16(1) Connecticut Insurance Law Journal, 97-156. Marwedel, W. and Espinoza, S. ‘Symposium: Troubled Waters – Admiralty Law: Insurance and Finance Issues – Dagger, Shield or Doubled-Edged Sword?: The Reciprocal Nature of the Doctrine of Uberrimae Fidei.’ (2009) 83(5-6) Tulane Law Review, 1163-1188. Struckhoff, J. ‘The Irony of the Uberrimae Fidei: Bad Faith Practices in Marine Insurance.’ (Summer 2005) 29 Tulane Maritime Law Journal, 287-312. Table of Cases Assicurazioni Generali SpA. V Arab Ins. Group [2002] EWCA Civ. 1642. Anglo-African Merchants Ltd. v Bayley [1970] 1 QB 311. Banque Keyser Ullman S.A. v Skandia (UK) Insurance (C.A.)[1990] 1 QB 665. Bates v Hewitt [1867] 2 LRQB 595. Becker v Marshall[1922] 11 Lloyd’s List LR 114. Brownlie v Campbell [1880] 5 App. Cas. 925. Carter v Boehm [1766] 97 Eng. Rep. 1162. Friere v Woodhouse [1817] 171 Eng. Rep, 345. Ionides v Pender [1874] 9 LRQB 531. Joel v Law Union and Crown Company [1908] 2 KB 863. Kausar v Eagle Star Insurance Co. Ltd [1997] CLC 129. Lambert v Co-operative Insurance Society, Ltd[1975] 2 Lloyd’s Rep. 485. Life Association of Scotland v Foster [1873] 11 M. 351. Mayne v Walter [1782] 99 Eng. Rep. 548. Noble v Kennoway [1780] 99 Eng. Rep. 326. North Star Shipping Ltd. v Sphere Drake Insurance Plc [2005] EWHC 665. North Star Shipping Ltd. v Sphere Drake Ins. Plc [2006] EWCA Civ. 378. Pan Atl. Ins. Co. Ltd. v Pine Top Ins. Col Ltd.; [1995] 1 AC 501. Strive Shipping Corp. v Hellenci Mutual War Risks Association (Bermuda) Ltd [2002] EWHC 203. Table of Statutes Marine Insurance Act 1906. Read More