Duty of utmost good faith

Duty Of Utmost Good Faith; Avoidance As A Discretionary Right

Avoidance as a remedy is implicit from the word deemed in the MIA.

“The duty of utmost good faith is not contractual in nature, but derives from the rule of law.”

In S.17 MIA 1906 a contract for marine insurance can be avoided for breach of the utmost good faith. The definition of good faith has been condemned as lacking fixed meaning because it is “lose and amorphous.” In CTI breach of S.17, 18(1) and 18(2) MIA 1906 which did not induce formation of the contract, was part of the question whether to allow insurers to avoid. The courts paid more attention to the summary presentation than to go back to pre 20th century case law and see how courts of the time dealt with insurer's avoidance. According to the archives the courts had an open willingness to avoid even the smallest of breaches the duty of utmost good faith. Namely that a ship had become stranded and the broker does not take notice of the Lloyds list entry or that a policy was overvalued or that goods are systematically undervalued to conceal that earlier policies are more exhausted than they appear to be. All these are but some examples of where insurers could easily avoid the marine policy for breach of duty. Its no wonder that S.17 and S.18 (1) MIA 1906 gives rise to such a readily available right to avoid.

The point is that anything not contemplated by the policy's specific wording was easily avoided, if it materialised. For this reason the reference to materiality in the MIA 1906 is supposed to be assessed if the policy itself was vague and not by virtue of the assureds' non disclosure. If the MIA 1906 is to be revised, the test for materiality should be left to instances where the insurer avoids and there is some discrepancy between the event causing loss and specific provisions in the policy. This will ultimately come about where there has been a breach of the utmost good faith. Any situation to the contrary the assured ship-owner will have to pay for the loss and either continue cover or seek cover elsewhere. If the insurer pays I would argue that the insurer might have an equitable claim against the assured. The reason for this being that the duty of utmost good faith creates a fiduciary type relationship.

Maybe a marine insurance policy is more similar to that of a trust or deed, given its nature and strict adherence to its fiduciary like relationship.

Unlimited Liability Of Assureds

A mutual club is where ship owners or ship operators as principles pool their resources to insure against usual risk against third party liability. To the P and I market the duty of utmost good faith gives rise to fiduciary type obligations and is the very basis on which business ought to be conducted. If changes are to be made to the MIA the duty of good faith should be retained.

Given insurers are agreeing to write risk that, on attachment, could give rise to a disastrous claim. In a private firm (such as a sole proprietorship or general partnership) its owners, partners, or stockholders accept personal and unlimited liability for its debts and obligations in return for avoiding the double taxation of a limited company. Unlimited liability firms are exempt from filing their annual accounts with a public authority (such as Registrar Of Companies) unless they are subsidiaries of limited liability holding companies.

A circular from the UK Protection and Indemnity Club states that before 1996 all P and I Club members risked unlimited liability. Post 1996 the circular suggested a compromise position whereby a club member (ship-owner) would be liable to 20 per cent exposure of risk which by many members was seen as being too high.

Reform - Drake V Provident

If one was to consider risk, then the assumption that the insured knows more than the insurer stands valid by the duty of disclosure in case law. This may not hold so much nowadays where this assumption is shifting especially with easier access of data via IT and through knowledge and expertise in risk assessment. In these circumstances remedy has been blamed as not flexible and severe, even in weak borderline cases, where avoidance for non disclosure being the only remedy.

The case of Drake Insurance v Provident Insurance indicates the need for more flexibility. Lord Hobhouse's judgment in The Star Sea, was considered by Lord Justice Rix where the duty of good faith may be more flexible than only giving a party the right to avoid. His statement was:

“The courts have consistently set their face against allowing the assureds duty of good faith to be used by the insurer as an instrument for enabling himself to act in bad faith.”

Lord Hobhouse concluded in The Star Sea case that;

“Such authorities show that suitable caution should be exercised in making any extension to the existing law on non-disclosure and that the courts should be on their guard against the use of the principle of good faith to achieve results which are only questionably capable of being reconciled with the mutual character of the obligation of good faith.”

Lord Justice Rix discussed the need of balancing rights and wrongs as a process not being favoured by English Commercial Law, which merely concentrates in simple testing for certainty. He proposed that in those cases where remedy is unfair, the insurer's right to avoid should be limited by applying the doctrine of good faith. He also commented on proportionality as a concept, but on the basis of giving wider effect to the good faith doctrine seeing it as necessary by the wide spreading of consumer contracts. He said:

“In my opinion it would be consonant with these views that the doctrine of good faith should be capable of limiting the insurer's right to avoid in circumstances where that remedy, which has been described in recent years as draconian, would operate unfairly.”

The Drake case dealt with the non-disclosure of a speeding conviction as well as with confusion between insured and insurer of the proper classification of a previous accident which in actual fact was a no-fault accident. To that effect Lord Justice Rix commented on the entitlement of the insurer to exercise his right to avoid the policy for non-disclosure:

“If, however, the point were a live one, I would hazard the opinion that knowledge or shut-eye knowledge of the fact that the accident was a no

fault accident would have made it a matter of bad faith to avoid the policy.”

And added:

“If it is right to allow that circumstances could arise where an insurer would not be in good faith by acting on a prima facie right to avoid for

non-disclosure, then the question would have to be faced as to the conceptual analysis whereby an exercise of a right to avoid could be invalidated by the insurer's bad faith. This is not an easy question.”

The general judicial recognition is that contract avoidance can operate badly against the insured if in breach of the duty of good faith. To make the law fairer on the insured, it is said that a less strict test of materiality should be adopted. In 1980 the Law Commission in its non-disclosure and breach of warranty report recommended that “the test of materiality should be whether, in the opinion of the reasonable assured, a fact known to him would influence the judgment of a prudent insurer.” Similarly in Australia, the Insurance Contracts Act of 1984 introduced a similar test, whereby matters known by the assured must be disclosed, which either he has knowledge of their relevance in accepting the risk and its terms by the insurer, or which in the circumstances a reasonable assured would be expected to know as relevant in the said context. In cases of non-fraudulent non-disclosure, the insurer's liability is reduced to reflect agreement made under proper disclosure.

Reform And Harmonisation

The doctrine of utmost good faith has its positive and negative points in that it is the one feature that is shared among most contracts of insurance and that it lacks clear definition and is based in an Act that is outdated. However on the principle that there have been centuries of case law constantly defining and redefining its meaning there are enough legal norms derived by it to justify its retention. The Comité Maritime International (CMI) proposes harmonisation in the area of marine insurance. Its guidelines address the notion of good faith and propose some changes that are to “negate its negative effects”. Since the Law commission has already published its draft Bill on consumer insurance law, could the MIA be amended so as to fit with harmonising measures proposed by the CMI?

The Australian treasury has already conducted a comprehensive review of the MIA 1909 that led to the Insurance Contracts Act 1984 (ICA). The ICA reformed the area of consumer insurance law that included the duty of utmost good faith as an implied term in insurance contracts. The main changes that were made included the abolition of warranties, insurable interest and a shift of the burden on proof onto the assured. In S.54 of the ICA, an insurer may not refuse to pay claims in certain circumstances. S.54 states

(1)  “Subject to this section, where the effect of a contract of insurance would, but for this section, be that the insurer may refuse to pay a claim, either in whole or in part, by reason of some act of the insured or of some other person, being an act that occurred after the contract was entered into but not being an act in respect of which subsection (2) applies, the insurer may not refuse to pay the claim by reason only of that act but the insurer's liability in respect of the claim is reduced by the amount that fairly represents the extent to which the insurer's interests were prejudiced as a result of that act.”

(2)  “Subject to the succeeding provisions of this section, where the act could reasonably be regarded as being capable of causing or contributing to a loss in respect of which insurance cover is provided by the contract, the insurer may refuse to pay the claim.”