The Supreme Court held that an insurer cannot refuse a valid claim merely because the insured told a collateral lie that made no difference to the right to recover. The owners of the DC Merwestone had a good claim for engine damage caused by seawater ingress, despite a manager’s reckless falsehood about a bilge alarm aimed at speeding payment. The majority distinguished such irrelevant lies from fabricated or dishonestly exaggerated claims.
On the night of 28/29 January 2010 the DC Merwestone, laden with scrap iron, suffered an ingress of water that flooded the engine room shortly after leaving Klaipeda. The flooding was caused by crew negligence in failing to close a sea inlet valve and drain the emergency fire pump, freezing damage to that system, contractors’ failure to seal cable penetrations in the engine-room bulkheads, and defective pumps that could not cope. The main engine was damaged beyond repair. The owners claimed some €3.241 million under their marine policy.
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The insurers’ solicitors sought an explanation. On 21 April 2010 Mr Chris Kornet of the managers emailed that the bilge alarm had sounded at about noon on 28 January and that the crew had been unable to investigate because of heavy weather. He presented this as information received from the crew. Popplewell J found that the account was a speculation Mr Kornet genuinely thought plausible, but that the claim to have been told it by the crew was a reckless untruth. Mr Kornet had not been told it and had no reason to expect the crew to support it. He lied because he was frustrated by delay and hoped, while the cause remained unclear, to focus attention on crew failure rather than on possible defects for which the owners might be responsible under the Inchmaree clause.
The lie proved irrelevant. Popplewell J held that the loss was proximately caused by a peril of the seas—the fortuitous entry of seawater through the inlet valve—and that the relevant part of the Inchmaree clause did not apply. He also rejected the contention that the owners had sent the vessel to sea in breach of the warranty implied by section 39(5) of the Marine Insurance Act 1906, because the managers had not known of the pump defects. The owners therefore had a valid claim for €3,241,310.60 whether or not the alarm story was true. The judge nevertheless held that the collateral lie forfeited the claim, while regarding that result as disproportionately harsh: the untruth was reckless rather than carefully planned, was told once, was not persisted in at trial, and supported a theory Mr Kornet genuinely believed plausible.
The fraudulent claims rule
At common law an insurer is not liable to pay a fraudulent claim. For contracts made after 12 August 2016 section 12 of the Insurance Act 2015 restates the rule and defines other consequences, but does not resolve what amounts to a fraudulent claim. Lord Sumption identified three situations. A wholly fabricated claim adds nothing to the insurer’s existing rights. A genuine claim whose amount is dishonestly exaggerated is the paradigm case: the insurer is not liable even for the justified part. The third situation, in issue here, is a claim that is entirely justified but is supported by dishonest embellishment—sometimes called a fraudulent device, which Lord Sumption termed a collateral lie. The question was whether the insurer may repudiate a claim because of a false statement that was irrelevant, in the sense that the claim would have been equally recoverable whether the statement was true or false.
The rule’s rationale is the deterrence of fraud, reflecting the informational asymmetry between insured and insurer. Lord Sumption treated the rule, once the contract is made, as an implied term or incident of the contract rather than simply as a continuing application of the pre-contractual duty of utmost good faith. The insurers sought only to defeat the particular claim, not to avoid the contract.
Why a collateral lie does not forfeit a valid claim
Lord Sumption, with whom Lord Clarke, Lord Hughes and Lord Toulson agreed, held that the rule does not apply to collateral lies. The insured’s right to indemnity arises when the loss is suffered. A later fraudulently exaggerated claim retrospectively bars even the honest part because the insured’s dishonesty is calculated to obtain something to which he is not entitled, and the law will not sever the invented part from the justified part. Where, however, the insured seeks only what the law regards as his entitlement and the lie is irrelevant to the existence or amount of that entitlement, the lie is dishonest but the claim is not. Forfeiture would protect the insurer only from paying, or from paying earlier, an indemnity for which he has been liable since the loss. That is no part of the mischief at which the rule is aimed, and avoidance of the claim would be a disproportionate response. The insured gains nothing from the lie to which he was not already entitled, and the insurer loses nothing by meeting a liability he had anyway.
Some connection between the lie and the claim is still required. Lord Sumption held that the lie must at least go to the recoverability of the claim on the true facts, judged with hindsight once those facts are admitted or ascertained. The rule therefore covers a fabricated claim and an exaggerated claim, including the genuine part of an exaggerated claim, but not a lie that the true facts show to have been immaterial to the right to recover. He rejected the approach, associated with Mance LJ in Agapitos v Agnew, of asking whether the lie would, if believed and before final determination, have tended to yield a not insignificant improvement in the insured’s prospects of settlement or success at trial. Materiality at the claims stage is not the same as pre-contractual materiality, because the insurer assessing a claim has no discretion: he is already bound if the claim is good, and his assessment is an attempt to predict what a court would decide.
Lord Hughes agreed in the result, adding that forfeiture of a wholly good claim is disproportionate once other consequences of discovery are taken into account, including loss of credibility, adverse costs, prospective termination of the policy, and the effect on future proposals. He also noted that the common-law rule has been confined so as not to catch fraud committed after litigation has begun, a limitation itself based on disproportion. Lord Clarke and Lord Toulson agreed that public policy does not require so harsh a sanction where the lie is immaterial to the existence or amount of the entitlement.
The dissent
Lord Mance would have dismissed the appeal. He considered that the fraudulent-claims principle should extend to fraudulent devices, assessed by reference to the circumstances when the lie was told. A lie told to influence the underwriter’s decision whether to pay is material to a central underwriting decision; judging it only with hindsight mistakes the nature of the claims process and gives the insured a one-way bet. He would have required that the device, if believed, would have yielded a significant improvement in the insured’s prospects. In his view the same deterrent logic that Parliament has preserved for fraudulent claims applies to devices used to promote a claim the insured believes or fears to be questionable, and the sanction is a proportionate bright-line rule.
On the majority’s view of the common law, the appellants’ further arguments under article 1 of the First Protocol to the Human Rights Convention did not arise.
Verdict: By four votes to one the Court allowed the owners’ appeal. Subject to submissions on the order, judgment was to be entered for €3,241,310.60 plus interest. The lie had made no difference to the owners’ entitlement under the policy.
Source: Versloot Dredging BV and another v HDI Gerling Industrie Versicherung AG and others [2016] UKSC 45
