Fraudulent claims in marine insurance law

Critically assess the extent to which the rules governing fraudulent claims in marine insurance law have been driven by the principle stated by Lord Hobhouse in The Star Sea [2001] Lloyd’s Rep. I.R. 493 at [63], that:

“The fraudulent insured must not be allowed to think: if the fraud is successful, then I will gain; if it is unsuccessful, I will lose nothing."

INTRODUCTION

In general contract law there is no general duty to volunteer information even though it is evident that such information would be regarded as highly relevant by the other party. This is because English law adopts an adversarial model of contractual obligations, requiring each party to accept responsibility for their own interests. [1] The law normally assists a party who has been induced into a contract by an inaccurate or misleading statement, termed as misrepresentation. However there is no general duty to volunteer relevant information to the other party.

Insurance contracts are an exception to the rule, and this is because they are contracts uberrimae fidei (of the utmost good faith) [2] . The duty of utmost good faith reaffirms the law of misrepresentation but also imposes a duty to volunteer certain information. Breach of the duty affords the innocent party the option of rescission of the contract i.e. the retrospective avoidance of a contract.

Before the common law courts would rescind a contract only on the basis of fraudulent misrepresentation (when the represent or knows that it is false, or does not believe it to be true or is reckless as to whether it is true or false). It was only in equity, that there could rescission for misrepresentation which were not fraudulent, and which were termed ‘innocent’ misrepresentation. Then with the fusion of law and equity by the Judicature Acts of 1873, the common law courts recognised a duty of disclosure and condemned non-fraudulent misrepresentations as well.

The concept of the fraudulent claims is compatible with the articles 17-21 of the Marine Insurance Act 1906, i.e. the section about the disclosure and representation. There are several cases to show that in general fraud consists a fraudulent claim.

DUTIES UNDER MARINE INSURANCE ACT 1906

According to section 17 [3] “a contract of marine insurance is a contract based upon the utmost good faith, and, if the utmost good faith be not observed by either party, the contract may be avoided by the other party". It derives from that part of the Act that Duty of Utmost Good Faith lies upon both parties and that the avoidance is one of the remedies, when there is a breach of this duty.

The Concept of the Duty of Utmost Good Faith was well explained by Lord Mansfield, in the case Carter v. Boehm [4] : Insurance is a contract upon speculation. 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, to mislead the underwriter into a belief that the circumstance does not exist, and to induce him to estimate the risqué, as if it did not exist. The keeping back such circumstance is a fraud, and therefore the policy is void. Although the suppression should happen through mistake, without any fraudulent intention; yet still the underwriter is deceived, and the policy is void; because the risqué run is really different from the risqué understood and intended to be run, at the time of the agreement.

The Duty of Disclosure exists before conclusion of contract, Therefore, it is a duty only at the pre-contractual stage, and once the contract is concluded there is no general continuing duty to disclose. If circumstances change between the presentation of the risk and its acceptance then the change must be disclosed (Assicurazioni Generali SPA v Arab Insurance Group [5] ). Such a Duty relates only to material circumstances and those circumstances are known or deemed to be known [6] by the assured and which would influence the judgment of a prudent insurer in fixing the premium, or determining whether he will take the risk. actually, materiality is a question of fact (Simner v New India Insurance Co, Economides v Commercial Assurance [7] ).

As for the Duty of Non-Misrepresentation according to Lord Mansfield in MacDowell v Fraser [8] it was held that an underwriter was entitled to avoid a contract on the basis of a non-fraudulent misrepresentation that a vessel had safely complete two-thirds of the insured voyage. In Ionides v Paific Fire & Marine Insurance Co [9] , a cargo policy was held to be vitiated by the misrepresentation “however honestly and innocently" made, that the goods were to be shipped on board of the Socrates instead of the Socrates. This is because the former was a new Norwegian vessel, while the latter was an old French ship.

FRAUDULENT CLAIMS

“Fraud means that the assured deliberately causes the loss for the purpose of receiving payment from the insurer. If the assured causes the loss deliberately, this will normally be fraudulent, but at least theoretically the assured may cause the loss deliberately but without fraudulent intent. Fraud could also constitute any action made with intentionally or in bad faith [10] . It can be excluded either by a general exclusion for any misconduct or negligence [11] or by an exclusion for loss caused by gross negligence [12] or willful misconduct, or from exclusions for loss caused by intent". [13] 

“The fraud must be : (1) substantial, (2) willful on the part of the insured and (3) material, i.e. having a decisive effect on the readiness of the insurer to pay" [14] .

Some types of fraud which could be distinguished are the below:

Possibility of gross recklessness in making a claim when a claim is made without in fact happening of any losses.

The losses could be true and covered but the assured lie about the circumstances in order to show he complied with the terms of the policy and or exclusions. S18 Marine Insurance Act 1906 circumstance means information received or communication made.

The loss may be genuine and covered and the assured lied to exaggerate the extent and the nature of the loss. 4. The loss may be genuine and may be covered by the policy but the assured may have employed a fraudulent device to induce the insurer to accept the claim." [15] 

In The Litsion Pride [16] , Mr. J. Herst, held that the assured had made a fraudulent claim and therefore the insurer could avoid the policy. The question is whether it would affect the whole policy or whether it will have a less dramatic effect. The key case is the House of Lords decision in The Star Sea [17] .

The Star Sea [18] : In that case there was a situation where some 33 vessels were covered under one insurance policy and it was alleged by the insurers that when the vessel caught fire, she became a constructive total loss as a result of that fire. The first defence was that the vessel was unseaworthy. It was failed because it was found that the master was clearly incompetent because he had not been trained to operate the fire fighting equipment. However section 39 (5) of the Marine Insurance Act, says: “In a time policy there is no implied warranty that the ship shall be seaworthy at any stage of the adventure, but where, with the privity of the assured, the ship is sent to sea in an unseaworthy state, the insurer is not liable for any loss attributable to unseaworthiness". Therefore there is no implied warranty and it is only if the assured has actual knowledge or at least constructive knowledge of the unseaworthiness i.e. that they must have had a reasonable suspicion, that the insurers can then be not liable for the loss attributable to the unseaworthiness. The insurers however did not manage to prove this. The underwriters then used the breach of the utmost good faith as a second defence. But it did not work. They claimed that the owners were in breach of this duty at the claim stage because when they tried to settle the claim they wrote to the underwriters and failed to disclose two expert reports in relation to the loss of two other vessels which had occurred previously. Both had also been lost in fire. The underwriters said that this was a breach of the duty of utmost good faith since the expert reports were relevant. In the House of Lords, it was held:

The duty of utmost good faith does not continue or even if it does, after court proceedings have been started, the duty is superseded by the court’s procedural rules. The House of Lords said that if there are documents pre-existing the loss which are relevant and were suppressed or deliberately destroyed, then the judge would strike out a claim for failure to produce relevant documents. The duty of the utmost good faith does not end but it is superseded by the court’s procedural rules.

At the claims stage the only type of conduct which could constitute a breach of the duty of utmost good faith is fraud. Therefore what Mr. J. Herst in The Litsion Pride [19] referred to as culpable behaviour was overruled by The Star Sea [20] . In order to claim breach of the utmost duty of faith in relation to claims, there needs to be fraud. In The Star Sea [21] the underwriters did not prove fraud, and therefore the defence of the breach of utmost good faith failed.

She would argue that if you treat it as pre-contractual obligation then it should be the general law and therefore there can be avoidance for innocent non-disclosure. If it is a truly new cover then there must be the normal pre-contractual duty. With the claims stage the House of Lords said that it is limited just to fraud.

In The Star Sea [22] there was no fraud on the part of the relevant person then there was no defence and the underwriters were liable. The House of Lords were keen to limit the continuing duty of utmost good faith. They acknowledged that there is the continuing duty, but they said that there is the court procedural rules should then kick in.

“... The law upon such a case is in accordance with justice and also with sound policy. The law is, that a person who has made such a fraudulent claim could not be permitted to recover at all. The contract of insurance is one of perfect good faith on both sides, and it is most important that such good faith should be maintained. It is the common practice to insert in fire policies conditions that they shall be void in the event of a fraudulent claim; and there was such a condition in the present case. Such a condition is only in accord with legal principle and sound policy. It would be most dangerous to permit parties to practise such frauds, and then, notwithstanding their falsehood and fraud, to recover the real value of the goods consumed. And if there is wilful falsehood and fraud in the claim, the insured forfeits all claim whatever upon the policy. This, therefore, was an independent defence; quite distinct from that of arson ... Sir Roger Parker said, at p. 452: The appellant submits that the law, in the absence of a specific clause, is that an insured may present a claim which is to his knowledge fraudulent to a very substantial extent, but may yet recover in respect of the part of the claim which cannot be so categorized. To accept this proposition involves holding that, although an insurance contract is one of utmost good faith, an assured may present a positively and substantially fraudulent claim without penalty, save that his claim will to that extent be defeated on the facts.. . .I can see. . .every reason why he should not recover at all. In my judgment this is not so. It appears to me that it is contrary to reason to allow an insurer to avoid a policy for material non-disclosure or misrepresentation on inception, but to say that, if there is subsequently a deliberate attempt by fraud to extract money from the insurer for alleged losses which had never been incurred, it is only the claim which is forfeit." [23] 

The case Galloway v Guardian Royal Exchange [24] the court of appeal decided to dismiss the hole claim because of fraud and therefore the insureds could not recover. The case was about a burglary claim

Fraudulent claims - case law after The Star Sea [25] 

We have moved away from it and the English courts have relied on a different defence. They have relied on a common law duty not to make a fraudulent claim which is implied in the contract. They have therefore stopped using the duty of the utmost good faith.

An example of such cases was The Aegeon [26] : An underwriter, A2, appealed against the dismissal of an application to amend his defence in proceedings instituted by an insured, A1, who sought an indemnity under a policy of marine insurance. The claim arose from the loss of a passenger ferry , the "Aegeon", as a result of fire damage. The vessel had been insured against hull and machinery port risks whilst undergoing maintenance work. A warranty had been given by the insured that a certificate from the London Salvage Association, LSA, would be obtained prior to the commencement of any "hot works". A fire subsequently occurred on the vessel whilst hot works were being carried out. A2 declined to indemnify A1 on the basis that there had been a breach of warranty relating to the requirement to obtain an LSA certificate. The date that hot works commenced fell to be determined as a preliminary issue. During the course of the litigation, A1 disclosed two sworn statements from individuals employed to work on the vessel who maintained that substantial hot works had been performed on a date eleven days prior to that upon which A1 had maintained that the work in question had commenced. A2 asserted that the policy was void for fraud and sought permission to amend its defence. At first instance the court held, on the assumption that A2 had a valid defence for breach of warranty, that any continuing duty not to deceive the underwriters was discharged by the breach. Conversely, on the assumption that A1 was entitled to succeed in his claim, the lies were only material in circumstances where the truth could have provided A2 with a defence to the claim, and on the hypothesis which the judge was considering the lies could not be material. The judge commented that he saw great force in the submission made on behalf of A1 to the effect that once litigation was underway, any duties previously owed to insurers pursuant to the Marine Insurance Act 1906, section 17 were superseded by the rules of litigation. Held, dismissing the appeal, that the duty of good faith under s.17 was superseded by the rules of litigation once proceedings had been commenced. It would be inappropriate to seek to draw any distinction between the common law duty in respect of fraudulent claims and the s.17 duty. Accordingly, the proposed amendments sought to raise a case which was obviously bad in so far as it depended upon allegations of lying, in breach of either a common law duty or a duty under s.17, after the commencement of litigation, Manifest Shipping Co Ltd v Uni-Polaris Insurance Co Ltd (The Star Sea) [2001] UKHL 1 applied and K/S Merc-Scandia XXXXII v Lloyd’s Underwriters (The Mercandian Continent) [2001] EWCA Civ 1275 considered. A fraudulent claim exists: “ where the insured claims, knowing that he has suffered no loss, or only a lesser loss than that which he claims (or is reckless as to whether this is the case)." A fraudulent device, on the other hand, is: “ used if the insured believes that he has suffered the loss claimed, but seeks to improve or embellish the facts surrounding the claim, by some lie."

In the case Axa General Insurance Ltd v Gottlieb [27] , Mr. Gottlieb and Mrs Gottlieb made a claim, and they were found to be fraudulent as to the first two claims. They had invented a claim for a cost that they said that they incurred in relation to costs for moving into another accommodation. They got a forged invoice. The insurers had already paid out part of the claims before the fraud was discovered. The insurers decided to claim back the money that had already paid and they did not base their defence on the breach of utmost good faith. On the other hand they based their defence on the common law duty not to make a fraudulent claim. They said that once the claimants were in breach of that duty they were entitled to recover the sums that were paid by them. The Court of Appeal held that the insurance company was entitled to recover the sums paid in relation to Claims 1 and 2 and not in relation to all the claims. This is because the third and fourth claims were valid, and there was no fraud. Therefore it is worth pleading on the common law rule of not making a fraudulent claim. It is an implied term of the contract. If it is an implied term then it would discharge both parties from performance as from the date of the fraud in relation to that claim. The court of appeal is treating each claim as separate and said that the insurers can cover claims 1 and 2 but not the others.

The Court said:

“There was no basis or reason for giving the common law rule relating to fraudulent claims a retrospective effect on prior, separate claims which had already been settled under the same policy before any fraud occurred. The cross-appeal was dismissed".

Therefore the Court here is underlying that once some claims had been settled before the fraud arose, the fraud does not work retrospectively. The question arises if the insurers had not paid out anything, and fraud was discovered, whether the finding of such fraud would discharge the insurer of payment, on the whole contract prospectively. The question is whether the insurer would theyn still had to pay for the third and fourth claims, if he had discovered the fraud prior to him having made any payment. This remains to be seen.

The Court continued saying:

“The rule relating to fraudulent insurance claims was a special common law rule. The proper scope of that rule was to forfeit the whole of the claim to which the fraud related, with the effect that the consideration for any interim payments made on that claim failed and they were recoverable. The appeal was dismissed".

In The Mercandian Continent [28] : A liability insurance where the works were negligent. They had insurance the ship repairers for negligent works. The shipowners seek to recover directly. The contract was between the ship repairers and the ship owners. The ship repairers had insurance with liability insurers. The ship repairers went into liquidation and therefore the ship owners seeked to recover directly from liability insurers. They had no contractual right to do so but they did had the right under an Act for Third Parties. The aforementioned Act entitles a third party to stand in the shoes of the assured where the assured has gone into liquidation or has become bankrupt or has a liability to the third party. It was thought that it would be better for the liability insurers if the claim were heard in Trinita de Bago since the limits would be lower than what they would be in England. These ship repairers forged a document to show that the person who signed the English jurisdiction agreement had not the authority to do so. They introduced a fraudulent device. However the advice was wrong and the limits were going to be the same whether they were held in the Trinita de Bago or England. Can the insurers say that the ship repairers had used a fraudulent device? The Court of Appeal held that with the duty of utmost good faith they could only avoid the claim if the consequence of the fraudulent device would be material i.e. would effect the ultimate liability of the underwriter. In this case it would not have any effect because the limits were the same. Therefore the underwriters were liable. The case was thought to be sensible because if the ultimate liability was not affected then the underwriters would be liable. Also it was suspected that because the shipowners were third parties, then maybe the English courts would feel sympathy towards them.

“... no question of making a claim under a liability policy arises until the liability of the assured is established (whether by agreement, judgment, or arbitration award)..." [29] 

The Game Boy [30] is another case in which the owners had sought to insure their ship for 1.8 m dollars and the Court said that its value was much less [31] . The owners to support this difference used fraudulent documents to support their claims. In this case the court said that the insurer does not have liability in respect of that claim. The fraud occurred before the court proceedings.

Reverting to The Star Sea [32] , we have one on one policy 33 ships. If someone claims that there is a breach of the utmost good at the claims stage and that there is fraud before court proceedings then the duty of utmost good faith could still apply, then there could be avoidance in respect of the 33 ships, measure which is extremely draconian. The logic has been expressed that the fraudulently inclined assured must not be allowed to think: “if the fraud is successful, I will gain; if it is unsuccessful, I will lose nothing" [33] .

REMEDIES FOR FRAUDULENT CLAIMS

Avoidance

Under section 17 of the Marine Insurance Act 1906 “a contract of marine insurance is a contract based upon the utmost good faith, and, if the utmost good faith be not observed by either party, the contract may be avoided by the other party", fact that The Mercandian Continent [34] recognises. On the contrary, in The Aegeon [35] , it was said that the section 17 is intended to apply only to the pre-contractual stage and not to the post-contractual stage. The insurance contract must be based on good faith.

Fraud related to the loss forfeits the right of assured to be indemnified in respect of that claim. Forfeiture relates not just to such part of the claim as may be fraudulent but to the entirety of the claim [36] . Thus, a payment on account in respect of a genuine loss covered by the policy will be recoverable to the insurer if the assured later uses a fraud device in order to influence the final statement of the claim even in the absence of any fraud at the time of the payment on account [37] .It also goes further and removes or bars the assured cause of action on the policy.

Contract Termination

A repudiatory breach of contract affords the insurer a right to elect to treat the contract as discharged or as on infringement of a duty arising under the doctrine of utmost good faith. According to The Aegeon [38] , fraudulent claims are to be treated as being independent from the duty of utmost good faith because of retrospective avoidance. It should suffice that the fraud is material to the claim. Once litigation starts, then the parties do have adversarial relationship and are governed by rules of court procedure or arbitral process.

The rule is that once litigation starts, the rule of civil procedure supersedes. The common law rules governing the making of a fraudulent claim fell outside the scope of section 17 of 1906 Act.

CASES

The Star Sea [2001] UKHL 1, [2003] 1 AC 469, [1997] 1 Lloyd’s Rep 360, [1995] 1 Lloyd’s Rep 651

Carter v Boehm (1766) 3 Burr 1905

Assicurazioni Generali SPA v Arab Insurance Group (BSC) [2002] EWCA Civ 1642, [2003] Lloyd’s Rep IR 131

Simner v New India Insurance Co Ltd [1995] LRLR 240, Economides v Commercial Assurance Co plc [1998] QB 587

MacDowell v Fraser (1779) 1 Dougl 260

Ionides v Paific Fire & Marine Insurance Co (1871) LR 6 QB 674

The Litsion Pride [1985] 1 Lloyd’s Rep 437

The Aegeon [2002] EWHC 247, [2003] QB 556

Galloway v Guardian Royal Exchange (1999) Lloyd’s report I.R 209

Axa General Insurance Ltd v Gottlieb [2005] EWCA Civ 112, [2005] Lloyd’s Rep IR 369

The Mercandian Continent [2001] EWCA Civ 1275, [2001] 2 Lloyd’s Rep 563

The Game Boy [2004] EWHC 15 (Comm), [2004] 1 Lloyd’s Rep 238

BOOKS

“The Law of Marine Insurance", Howard Bennett, second edition, 2006, Oxford University Press

“Law of Marine Insurance", Susan Hodges, 2005, Cavendish Publishing Limited

“Doctrines and Principles, Insurance Law", John Lowry and Philip Rawlings, second edition, 2005, Hart Publishing

“Southampton on Shipping Law", Institute of Maritime Law, 2008, Informa, London

ARTICLES

“Current Issues in Marine Insurance and Reinsurance Law", Professor Rob Merkin, 22-23 February 2005

“The Star Sea - the continuing saga of utmost good faith", Norma J. Hird , Journal of Business Law, 2001

“Fraud and sinking ships in marine insurance", Hugo Tiberg

“Fraudulent Insurance Claims", Rhys Clift - Partner Hill Dickinson LLP, March 2007

“Insurance Contract Law Issues Paper 2 - Warranties", Law Commission, November 2006

“Marine insurance paper", CML 625 S, Erik Reinmuth, 2005

“Reforming Insurance Law: is there a case for reverse transportation? A report for the English and Scottish Law Commissions on the Australian experience of Insurance Law reform", Robert Merkin

“Issues of marine insurance, Misconduct of the assured and identification", Professor Trine-Lise Wilhelmsen, Scandinavian Institute of Maritime Law

“Non-disclosure and breach of warranty issues in the light of English Reform of the Marine Insurance Law", Kozubovskaya-Pellé Anastasiya, Centre de Droit Maritime et Océanique, Université de Nantes, Vol. 14, 2008/2 http://www.cdmo.univ-nantes.fr/centre-droit-maritime-oceanique/cdmo

“Policies and Perceptions of Insurance Law in the Twenty-First Century", Malcolm Clarke, Oxford University Press, 2005

“Construction Contracts, Law and Practice", Richard Wilmot-Smith, Oxford University Press, 2006

“The Marine Insurance Act centenary, a cause of celebration?", Richard Cornah Chairman – Richards Hogg Lindley Vice Chairman – Association of Average Adjusters 20th April 2006

“Utmost Good Faith", Andrew Tulloch,

“Acting in good faith: the terms are still confusing", Roger Kay, Coventry Law Journal, 2001

“Blind eye privity and bad faith in insurance claims", Malcolm Clarke, Cambridge Law Journal, 2001

“Contract law and the law of insurance", Daniel Friedmann, Law Quarterly Review, 2004

“Fraudulent claims: framing the appropriate remedy", John Lowry and Philip Rawlings, Journal of Business Law, 2006

“Fraudulent insurance claims: recent legal developments", Julie-Anne R. Tarr , Journal of Business Law, 2008

“Recent cases on Marine Insurance", Paul Finn, 22 August 2007

“The saga of the continuing duty of utmost good faith - the sequel", Norma Hird, Journal of Business Law, 2002

http://www.kennedys-law.com/media/docs/Exaggeratedandfraudulentinsuranceclaims_2642006.pdf

http://www.onaolapo.org/journals/DHF.pdf

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