Insurance Law Reform to Deterring Fraud

Insurance Law Reform: Deterring Fraud in The Twenty-First Century

Post By: Insurance Top Stories

The purpose of this paper is to provide a critical examination of the current law and the possible changes that are under consideration by the Law Commissions, after public consultation in relation to the continuing duty of good faith and post-contractual duties owed by the insured towards the insurer.

1. What is fraud?
The definition of what constitutes a fraud, or more correctly, the tort of deceit emanates from the ratio ofDerryv.Peek[2] where the House of Lords held that there were two elements necessary to constitute a fraud. First “[...] there must be proof of the fraud, and nothing short of that will suffice”[3] and second there has to be a false representation. This second element can be subdivided into three situations in which a false statement could amount to a fraud. “[F]raud is proved when it is shewn that a false representation has been made (1) knowingly, or (2) without belief in its truth, or (3) recklessly, careless whether it be true or false”[4].

Insurance Law Reform to Deterring Fraud

In all of these cases it is necessary that the deceiver has acted willfully. This is perhaps the most difficult element to prove. The insurer has to prove that the insured acted with deliberate intention and this is not straightforward as the insurers’ discovered when they failed to prove that the insured deliberately started a fire to claim from the insurance inJamesv.CGU Insurance plc[5] or where he deliberately sank his own ship inThe Italia Express[6]. Although the standard of proof when alleging fraud in civil cases is on the balance of probabilities, or as Lord Nicholls stated In Re H[7] more “likely than not”[8] to be fraud, as fraud is the most serious allegation to make, there must be strong, or better quality evidence of such before the court will be willing to hold that there is a fraud on the balance of probabilities. This was the conclusion Denning L.J. reached inHornalv.Neuberger Products Ltd[9] where he states: [...] the standard of proof depends on the nature of the issue. The more serious the allegation the higher the degree of probability that is required, but it need not, in a civil case, reach the very high standard required by the criminal law[10].

Moreover, inRe H and Others (Minors)[11] Lord Nicholls observed that as allegations of fraud are serious “[...] the stronger should be the evidence before the court concludes that the allegation is established on the balance of probabilities [...] ”[12]. Of course, if the insurer can prove that the insured knew his statement to be untrue (such as fabricating a burglary as in Shootv.Hill[13]) or was reckless, or careless that insured did not entertain a belief that there was any truth in his statement (such as claiming for a loss that never occurred), then he requires more than mere negligence for no matter how grossly negligent the insured may be “[...] the leading cases are replete with statements of its vital importance and of warnings against watering down this ingredient into something akin to negligence [...]”[14].

If the representor honestly believed in the truth of his statement then no action would lie against him in the tort of deceit. Therefore, the insured must be dishonest. This requires knowledge on behalf of the insured and even recklessness can be classified as dishonest if the has no belief in the truth. This was emphasized inAngusv.Clifford[15] Bowen L.J. stated:

Not caring, in that context, did not mean not taking care, it meant indifference to the truth, the moral obliquity of which consists in a wilful disregard of the importance of truth, and unless you keep it clear that that is the true meaning of the term, you are constantly in danger of confusing the evidence from which the inference of dishonesty in the mind is to be drawn – evidence which consists in a great many cases of gross want of caution – with the inference of fraud, or of dishonesty itself, which has to be drawn after you have weighed all the evidence[16].

This is analogous to the defendant’s state of mind in criminal cases[17]. Indeed this cyteria (having a combined subjective and objective test) was also used adopted as the appropriate civil test by the House of Lords inTwinsectra Ltdv.Yardley[18] before the Privy Council denied that this was the position inBarlow Clowesv.Eurotrust[19]. However, this has not prevented the courts from ignoring the decision inBarlow Clowes and applying the combined test as can be seen in the recent decision inAviva Insurance v.Brown[20], where the insured was held to have been dishonest on the basis of the combined test. Nevertheless, in order to prove fraud in the insurance law context there are also two additional criteria namely:
(1) materiality; and
(2) substantiality.

(1) The fraud has to be material
The post-contract position is similar to the pre-contractual position as defined in Pan Atlantic Insurance Company Ltdv.Pine Top Insurance Company Ltd[21] where the House of Lords held that there were two tests to be applied. The first was the “decisive influence test” in relation to materiality. This is where the insured has misrepresented or omitted an important fact. The test asks whether the fact is material on an objective basis by reference to a “prudent insurer” and whether he would have accepted the risk on different terms or not at all. Thus, is removes the subjective intentions or actions of the actual insurers. The second test was the “actual inducement” test; did the material fact actually induce the insurer into the contract? If the answer to both of the questions is yes then there will be an actionable non-disclosure or misrepresentation that allows the insurer to avoid the contract. These tests effectively require there to be a causative link to be established, effectively an equivalent of the “but for” test in tort, i.e. the insurer would not have entered a contract “but for” the breach of the duty of good faith.

Insurance Law Reform to Deterring Fraud

In a post-contract situation there is a similar two-stage test in relation to materiality and inducement. Materiality requires a causal link to the insurers’ liability. This was established by Rix J. inRoyal Boskalis Westminster N.V.v.Mountain[22] in this case the insured ship owners sought to conceal a “Finalisation Agreement” and some clandestine payments to the Iraqi Government, contrary to the sanctions imposed by the United Nations. The insured then claimed that they were not allowed to keep a copy of the “finalisation agreement.” Rix stopped short of classifying this conduct as fraudulent, but did agree that it amounted to a misrepresentation and non-disclosure. He considered whether post-contract materiality required the insurer to have relied upon the statement and this must be causally relevant to the insurers’ liability[23]. Longmore L.J. approved of this approach to materiality in the Court of Appeal decision of theMercandian Continent[24] where he states:

I would nevertheless gratefully borrow the concept that the conduct of the assured which is relied on by underwriters must be causally relevant to underwriters’ ultimate liability or, at least, to some defence of underwriters before it can be permitted to avoid the policy.

This is, I think, the same concept as that underwriters must be seriously prejudiced by the fraud complained of before the policy can be avoided[25].

Furthermore, in relation to the inducement it was held by Longmore L.J. that the insured should induce the insurer and this “is part of the general law [...] [and] is understood to apply to insurance law generally and marine insurance in particular”[26]. He continues:

“Avoidanceab initiois an even more extreme form of contractual termination than an acceptance of repudiatory conduct [...]” and there must be:

[...] at least the same quality of conduct as would justify the insurer in accepting the insured’s conduct as a repudiation of the contract. It is only in this way that the requirement of inducement for pre-contract conduct resulting in avoidance can be made to tally with post-contract conduct said to entitle the insurer to avoid the contract [...] In this way the operation of section 17 post-contract has the appropriate symmetry to the operation of the section pre-contract[27].

This statement has however drawn some criticism. The Law Commissions states, “It is unclear how far this requirement limits an insurer’s ability to avoid a policy from inception”[28]. They support this with the authority from Hoffman L.J. (as he then was) in Orakpov.Barclays Insurance Services Co Ltd[29] where he held “any fraud goes to the root of the contract and entitles the insurer to be discharged”[30]. What is clear is that the insurer will need to have dealt with the claim in a different way, “but for” the fraud. So the fraud will have had some impact on the claim, thus rendering it material. In most cases the fraud will be material if the insured has done or said something willfully or recklessly which misleads the insurer.

Materiality and the use of fraudulent devices to support a claim.InThe Mercandian Continent[31] the insured was in the business of repairing ships in Trinidad and had carried out a repair to the engine of the ship in question. They had however, failed to us reasonable care and skill when tightening some engine bolts. This resulted in the engine exploding. The ship owner sued the repairers and the repairers notified their liability insurers, but the company entered liquidation. This resulted in the ship owners suing the repairers liability insurers under the Third Party (Rights against Insurers) Act 1930. The insured had forged a document (or device) that purported to establish Trinidad as the correct jurisdictional forum to hear the case and gave this to the insurer.

This was based on the erroneous belief that the limitation period for such an action was shorter in Trinidad than in the UK. The insurers based their defence on fraud. However, it is worth noting that the insurers were not the victims of this fraud. It was designed to injure the ship owner’s ability to recover the indemnity. The Court of Appeal held in favour of the ship owners. The device was an immaterial forgery and therefore not relevant when refusing the ship owner’s claim based on the insured’s lack of good faith. This would not in effect pass the “but for” test as it would not alter the way in which the insurer handled the claim “but for” the fraud.

This type of fraudulent device can be seen inThe Liston Pride[32]. This case involved war risk insurance where the insurer will not insure the ship if it is in a particular geographical area that is subject to hostilities. However, if the insured notifies the insurer that it needed to enter such an area then the insurer insures the ship for an additional premium. In this case the owners of the ship chose to enter such a war zone in the Gulf when Iran and Iraq were at war, without notifying the insurers, thus hoping to save themselves a payment of an additional premium. The ship was spotted in the area by the Iraqis and was sunk by Iraqi helicopters. The insured then wrote a letter purporting to inform the insurer that the ship would be entering a war zone and back-dating it prior to the date when they entered the war zone so as to give the whole event an innocent explanation. Thus, they were hoping that this would conceal their fraudulent antics whilst simultaneously depriving the insurer of his premium. The plaintiff was the mortgagee seeking to recover the indemnity. It was held by Hirst J. that the ship was insured, based on other grounds and that this was a genuine claim, but a fraudulent device was used to support and improve the chances of recovery. The fraudulent device was used to perpetrate the fraud and this was either outright deceit or a breach of good faith. It made no difference which, as the outcome was the same[33].

What remains clear is that, according to Professor Clarke a fraudulent device “[...] is more than just a lie, it is a lie which is a means to an end” (Clark, 2009, p. 896, para 27-2B4). This can be seen inThe Aegeon[34] where the insured misled the insurer as to the dates in which “hot works” had begun on the ship in order to claim from the insurance. The fraud was discovered and the Court of Appeal held for the insurers. Mance L.J. explains what constitutes a fraudulent device and how it differs from a fraudulent claim:

A fraudulent device 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. There may however be intermediate factual situations, where the lies become so significant, that they may be viewed as changing the nature of the claim being advanced [35].

This means that the fraudulent device “[...] is a false statement directly in relation to the claim intended to improve the prospect of obtaining a settlement, including the prospect of payment sooner rather than later”[36]. And Mance L.J. inThe Aegeonalso emphasised the need for the fraudulent device to be tested against materiality:

[...] the courts should only apply the fraudulent claim rule to the use of fraudulent devices [...] which would, if believed, have tended, objectively but prior to any final determination at trial of the parties’ rights a yield to not insignificant improvement in the insured’s prospects [...][37].

This can still be seen to be similar to the “but for” test as previously mentioned, whereby the insurer would not be liable “but for” the use of the fraudulent device that changes the way in which the insurer deals with the claim.


(2) The requirement that the fraud is substantial
There is a requirement that the fraud itself must be more thande minimis;it must be substantial for it to be actionable. InLekv.Matthews[38] the insured claimed £44,000 on his policy after the theft of his stamp collection. The police subsequently discovered the album still with some stamps inside. The insurer refused the claim on the basis that some of the stamps were counterfeit and also that the insured had never owned other stamps for which he was claiming. Viscount Sumner stated:

[...] As to the construction of the false claim I think it refers to anything falsely claimed, that is anything not so insubstantial as to make the maxim de minimis applicable [...][39]. Clearly the fact that the insured was claiming for stamps that he had never owned was substantial. The next issue was whether the substantiality referred to the financial amount claimed or whether it referred to an incorrect statement on the subject matter. His Lordship answered this by saying that it:

[...] is not limited to a claim which on the whole is false. It means claims as to particular subject matters in respect of which a right to indemnity is asserted, not the mere amount of money claimed[40].

Therefore, the fact that the insured did not own these stamps was not ade minimis issue, it was a substantial misrepresentation of the subject matter when he incorrectly represented to the insurer that he did own them. Viscount Sumner continued by echoing theratioin Derryv.Peek“[...] A claim is false not only if it is deliberately invented, but also if it is made recklessly, not caring whether it is true or false [...]”[41].

Whilst the insured may not have deliberately invented the missing stamps, it was sufficient that he acted recklessly. Nevertheless, his Lordship doubted the honesty of the insured by claiming for that which he had never possessed, stating “[...]itisa contradiction in terms to say that he may have honestly believed in his claim”[42]. This was the opposite of the view taken by the Court of Appeal.

In relation to substantiality inGallowayv.Guardian Royal Exhange (UK) Ltd[43] the insured fraudulently added a claim for a computer (£2,000) to an otherwise genuine claim for £16,133 worth of goods[44]. The first issue was whether the fraud was material. Lord Woolf M.R. stated:

In determining whether or not the fraud is material [...] one [...] has [...] to look at the whole claim[45].

In this case it was determined that the claim was material; then it had to be ascertained if it was also substantial. Lord Woolf in the Court of Appeal held the correct approach was that:

• the fraudulent claim should be considered in isolation; and
• then it should be decided whether it was sufficiently serious as a proportion of the entire claim as to be considered substantial.

However, Millett L.J. did not share this interpretation and considered that the better approach was to:

[...] consider the fraudulent claim as if it were the only claim and then consider whether taken in isolation, the making of that claim by the insured is sufficiently serious to justify stigmatizing it [...][46].

These two differing approaches left Mummery L.J. with a decision as to which one to follow. He chose to agree with both. This was unfortunate, as by his action he created an element of uncertainty as to which test should be applied. What is clear is that in both judgments the fraud is considered in isolation and in this case fraud was substantial (representing nearly 10 per cent of the whole claim); this tainted the whole and as a result the insured recovered nothing.

The court however did have a choice. It could have severed the illegal part of the contract. This would allow the enforcement of the remainder. For the courts to follow this path there would be a need for the illegal element of the contract not to offend morality. In this case morality is offended, as there is a dishonest intention to commit a criminal fraud, a point that Professor Clarke makes[47]. Therefore, the whole claim is tainted and the illegal part cannot be severed. By taking this approach the court wanted to discourage bad behaviour whilst simultaneously encouraging honesty. This approach to forfeiting the whole claim was confirmed by Lord Hobhouse, with the agreement of Lords Hoffmann and Steyn inThe Star Seawhere his Lordship observed “[...] the insured who has made a fraudulent claim may not recover the claim which could have been honestly made”[48].

In Micro Design Group Ltdv.Norwich Union Insurance Ltd[49] the insured has suffered a burglary and wanted to be indemnified to the extent of £400,000. These losses were reflective of the computer hardware and software that was stolen.

However, the insured sought to reclaim a sum of £7,900þVAT from the insurers “[...] to recreate drawings, as a matter of urgency, in order to deal with [a] fresh application for planning permission”[50]. This would have represented approximately 2 per cent of the whole claim. It was held[51] that this was a fraud and this tainted the whole claim, freeing the insurers from any liability.

By way of contrast inTonkinv.UK Insurance[52] the insured’s house caught fire and he claimed for reinstating the house, but more specifically, £2,000 for reinstating the kitchen and under-floor heating system[53] a claim which had previously been settled. It was held by Peter Coulson Q.C. in the High Court rather than the claim for £2,000 being part of a fraud, it was “clearly and obvious and inadvertent mistake”[54]. Having reviewed the authorities on fraud he continued:

It seems to me that in circumstances like this, it is appropriate to give the benefit of any real doubt to the Claimants. That, therefore, is what I do here in rejecting the allegation of fraud. I should also say, for completeness that, having found that any fraud would have had to have been substantial (in the sense of not being “de minimis”) I do not accept that, even if the claim in respect of the kitchen and under-floor heating was dishonest and fraudulent, that fraud would have tainted the whole claim. The alleged fraud appears to be worth no more than £2,000. That is, on any view, not more than about 0.3% of the entirety of the Claimants’ claim in these proceedings. I do not consider that that is “substantial” in accordance with the authorities[55].

Whilst this judgment does give the insured the benefit of the doubt the insured should surely know whether or not the insurer’s have paid out a claim for a new kitchen or not. In this case the fraud was not alleged until the time of the trial and it was held that the insured could spend the insurance money on other things and not just replacing items that were lost. Thus, taking a sensible and not charitable approach[56].

Exaggerations. A claim will not be fraudulent if it is an exaggeration of a claim intended to open negotiations. However, there needs to be a clear understanding of the differences between an exaggerated bargaining position and an over exaggerated or grossly exaggerated statement which oversteps the mark and becomes a substantial fraudulent statement. InLondon Assurancev.Clare[57] Goddard J. directed the jury that a statement was not fraudulent just because it was exaggerated “[...] for a man might honestly have an exaggerated idea of the value of the stock, or suggest a high figure as a bargaining price”[58]. In Ewerv. National Employers’ Mutual General Insurance Association[59] MacKinnon J. (as he then was) held that when valuing the fire damaged goods the figure “looks preposterous”[60] when the plaintiff put down the cost price of new replacement items and not their second hand value. He continued:

I do not think he was doing that as in any way a fraudulent claim, but as a possible figure to start off with, as a bargaining figure. The plaintiff knew the claim would be discussed, and probably drastically criticised, by the assessors; he had been asked for invoices, and he started the bargaining with them by putting down the cost price of these articles as if they were new[61].

InNsubugav.Commercial Union[62] Thomas J. had a similar approach to MacKinnon, although slightly narrower. In this case:

[...] it is my view that very clear evidence of fraud would be required because one has to accept as a matter of commercial reality that people will often put forward a claim that is more than they believe that they will recover. That is because they expect to engage in some form of “horse trading” or other negotiation. It would not generally in those circumstances be right to conclude readily that someone had behaved fraudulently merely because he put forward an amount greater than that which he reasonably believed he would recover[63].

Thomas J. ultimately followedOrakpov.Barclay Insurance Services Co Ltd[64] in which it was held that the claim for fire damage to shop premises and contents should have succeeded, but was undermined by fraud.

InOrakpov.Barclay Insurance Services Co Ltdthe insured falsely claimed that his property, that was divided into 13 bedsits, in London was in full occupation at the time of damage by burst water pipes, and later by storms and vandals. The total claimed amounted to approximately £265,000 of which £77,000 related to the ultimately fabricated rent as only three of the rooms were let at the time of the damage. The Court of Appeal agreed with the judge at first instance[65], on the grounds of a material misrepresentation and fraud as the insured had deliberately exaggerated his losses. On the point of exaggeration Staughton L.J. (in a partially dissenting judgment) commented:

It is, I think, clear that the part of the claim based on loss of rent was indeed grossly exaggerated [...] Of course, some people put forward inflated claims for the purpose of negotiation, knowing that they will be cut down by an adjuster [...] From time to time claims are patently exaggerated [...] In such a case [...] the falsity of what is stated is readily apparent. I would not condone falsehood of any kind in an insurance claim. But in any event I consider that the gross exaggeration in this case went beyond what can be condoned or overlooked[66].

Therefore, provided that the exaggeration is not substantial, the courts are somewhat more lenient before branding something as fraud. Hoffman L.J. (as he then was) held on the point of exaggeration:

[...] One should naturally not readily infer fraud from the fact that the insured has made a doubtful or even exaggerated claim. In cases where nothing is misrepresented or concealed, and the loss adjuster is in as good a position to form a view of the validity or value of the claim as the insured, it will be a legitimate reason that the assured was merely putting forward a starting figure for negotiation[67].

Thus, the attitude of the courts is that exaggeration is reflective upon a negotiating stance and this is to be accepted rather than the insured providing a true valuation and then driven down through negotiations to accept less than the true value. Both of their Lordships were clear that the policy would not be avoidable by the insurer upon an exaggeration by the insured that was obvious to the insurers through investigation which includes reference to objective information. The real problematic issues arise when something is grossly exaggerated and crosses the line, becoming a substantial fraud as was held inGalloway.Effectively in this case the objective evidence is absent (such as a receipt from the sale of the computer) and so the fact that there is no objective information, when connected to a positive misrepresentation of the loss, the claim is more likely than not to be treated as a fraud.

The situations of fraud or exaggeration can easily be seen in those instances when an insurer asks the insured the value of the goods they are insuring. There may be those insured who, when asked the value of their car to be insured, would respond:

• with a value higher than that which they have paid; or
• an over estimate of current market value, knowing that should the car be written off the insurer would wish to pay out a lower amount than that which the insured paid for the vehicle in the first instance.

Whilst this value may well represent the difference due to depreciation, wear and tear, the insurer is doing no more than indemnifying the insured at the lowest possible sum, which would probably reflect the trade value of the car and not the retail price. Thus, the insured is positioning himself for the purposes of negotiation and, as the courts have observed, this exaggeration is lawful based on objective information available such as vehicle book values published in trade journals or motoring magazines.

Furthermore, it may be that the insured holds an honest opinion about the price of the goods to be insured. If they are over insured or under insured, provided that the insured has reasonable grounds on which to base his belief in relation to the sum involved, it is unlikely that this would amount to any fraud as the insured has acted innocently, this can be seen in the pre-contractual good faith issues inEconomidesv.Commercial Union Assurance Co Plc[68] where the Court of Appeal held[69] the insurer liable to the insured for the full value of the goods (some £30,000) when the insured had under-insured the goods (for £16,000) that were subsequently stolen. This approach mitigated the harshness of the avoidance remedy. The insurer was prevented from avoiding his policy obligations in this instance for an innocent misrepresentation or non-disclosure which falls under the wider ambit of dealing in good faith.

As previously stated, the problems for the insured arise when the goods are grossly over-insured, for the insurer may keep the premium and avoid paying out on the policy. InO’Connellv.Pearl Assurance plc[70] the insured insured a mare that was in foal for £200,000 and £60,000, respectively. The foal was born prematurely and was euthanized with the mare dying shortly afterwards. The insured claimed upon the policy and the insurers refused to pay on the basis that they suspected the insured of deliberately causing the deaths of the horse and foal in order to claim upon the insurance policy as the insured had overvalued the mare by ten times its actual value. However, the insured’s position could not be maintained based on the evidence. It was held that such a grossly exaggerated value constituted a fraud, but the foal was insured for the correct value.

2. The nature of the fraudulent claim
Any claim presented to an insurer could contain an element of fraud. InLekv.Matthews[71] it will be recalled that the insured claimed £44,000 on his policy after the theft of his stamp collection and he maintained an action against the insurer to recover an indemnity for stamps that he had never owned. The misrepresentation would have been made at the time of submitting his list of losses to the insurer. Whilst his conduct and intention could have been willfully fraudulent, the alternative was that he did not care what he disclosed his losses to be and was therefore fraudulently reckless. In some respects the insured’s actions were akin to strict liability. The losses did not occur and therefore it was a misrepresentation. Recently the insurers have to overcome the hurdles of the insured claiming that he made a misrepresentation, but that it was either innocent and negligent and therefore the insurer may either be fully or partially liable.

Notwithstanding this, if the insured made a list of losses that he genuinely believed that he had suffered and subsequently discovered that some of the stamps were not stolen but had been placed in a drawer and forgotten about until they were rediscovered then the fraud would be apparent if the insured willfully continued to maintain the claim. So it is possible that under some circumstances an honest claim can become dishonest, a point that Mance L.J. made inThe Aegeon[72] so the issue becomes one as to what degree of knowledge or willful conduct is required for a fraud to be committed. “The relevant test must be honest belief”[73] and this is more than merely suspicion[74]. Thus, if he had innocently misplaced the stamps and post-theft believed they were stolen, if he was honest, he would inform the insurer and withdraw the claim, unless the loss was covered under the contents policy, in which case the claim should be reformulated and submitted as a loss claim.

3. Remedies

One of the major confusions when discussing what remedy should be appropriate is that there has not been a consistent single approach by the courts to explain the remedy available to the insurer. This can be broken down into four categories. The first is by the use of an express term in a contract. The second is by implying a term into the contract. The third is by reference to the s. 17 Marine Insurance Act 1906 and the fourth relates to public policy considerations.

(i) Express terms
Express terms can be used to stipulate the remedy available. The remedies available depend in part upon how the contract is drafted. A well-drafted express term does not only define what constitutes fraud but also the remedy in the event of a fraud. The clause may take different forms, but generally they can extend the definition of fraud to include the use of fraudulent devices, or even extend the definition to include exaggerations. The boundaries of what a fraud can encompass can thus be extended by the use of such a term.

The express term may explain that the fraudulent claim may be forfeited or extended so as to require the fraudster to repay any genuine claims made prior to the fraud. Whilst the insurer will have given careful consideration to the drafting of such clauses, they are still subject to the common law rules ofcontra proferentumgiving the benefit of the doubt to the insured. Thus, a clause drafted so that all previously genuine claims had to be repaid upon the insurer discovered a fraudulent claim would be enforceable only if it was clearly expressed, as there is no statutory guidance on whether a clause is reasonable under the Unfair Contract Terms Act 1977 since insurance contracts are exempt under schedule 1, s. 1(a) of the Act.

However, some assistance does exist in the form of the Unfair Terms in Consumer Contracting Regulations 1999 that requires standard form consumer contracts to be fair (arguably a lower standard than that of reasonableness in the UCTA) and written in plain intelligible language. Therefore, if some clauses related to “fraud” and (whether it is committed using “fraudulent means or devices”) will have to be clearly drafted in plain English otherwise the ordinary insured may be more likely to question what these are, than understand the technical nature of these words.

If a badly drafted clause is deemed unenforceable, or the contract is silent on the issue, the fallback position will be to imply a term.


(ii) Implying a term
It is possible as a matter of fact or law to imply a term into a contract that the insured will not present a fraudulent claim or that the insured will act in good faith. As the insurance contract already has business efficacy a term cannot be implied on the basis of the Moorcock. However, it may be possible to imply a term under the officious bystander test[75] for if both parties were at the time of contracting being open and honest, i.e. dealing in good faith, then the question to be asked could be “do the parties agree not to engage in fraudulent conduct?” The reply would be a testy “of course.” This is provided it was necessary under the circumstances; and the insured could not argue that this is not be a case of not knowing there should be a term not to act fraudulently[76] as both parties would clearly agree to it if they were being reasonable.

Moreover, it would be possible as a matter of law to imply a term into a contract that the insured would agree not to act fraudulently or present a fraudulent claim. The courts would do this irrespective of the parties’ intentions at the time of contracting. To imply such a term would require the courts to satisfy the criteria established by the House of Lords inLiverpool City Councilv. Irwin[77]. First the insurance policy must be incomplete, i.e. it would want for a term to exclude fraud. The second question is whether the requirement that the contract is of a sufficiently common type has been met; and this criterion would easily be met by a contract for insurance. The third criterion is that the implied terms to be imposed must be reasonable in relation to the parties’ expectations.

An example of how the courts have addressed the issue of implied terms can be seen inOrakpov.Barclays Insurance Services Co Ltd[78]. In this case there were two issues that fell to be determined by the Court of Appeal. The first was whether there was a material misrepresentation that induced the contract, upon which the court held unanimously that there was and resultantly the contract was voidable by the insurer. This was a matter ofratio. The second issue was in whether there was an implied term that the insured would not act fraudulently. This was discussed as a matter ofobita. Straughton L.J.[79] in a dissenting judgment, listed the arguments of the insurer defence pleadings, namely that:

• a term should be implied as a matter of business efficacy;
• the officious bystander test; or
• implied by law.

First his Lordship expressed, perhaps surprisingly, that there was no express term addressing fraud, before discounting the business efficacy test and officious bystander test without any detailed explanation and holding that the term could be implied as a matter of law. He stated:

Why did the draftsman omit the provision which had previously been so common? Can he have done so by accident? Or was he afraid to spell it out in words that all would understand? I do not know of any other corner of the law where the plaintiff who has made a fraudulent claim is deprived even of that which he is lawfully entitled to, be it a large or small amount. I certainly would not imply such a term in order to give business efficacy to the contract, or because it is so obvious that it goes without saying. But [...] it is to be implied as a matter of law; in other words, it is a term which the law imposes unless the parties contract out of it[80].

His Lordship continued in relation to implying a term as a matter of law that:
I can readily accept that there is a duty not to make fraudulent claims; but I have doubts about the suggested punishment for breach of that duty. True, there is distinguished support for such a doctrine.Willes J. told the jury in Brittonv.Royal Insurance Company [1866]4F & F 905, 909 that an express condition to that effect was “only in accordance with legal principle and sound policy”[81].

It was the doubt about the punishment that led to his dissenting judgment[82]. For whilst a term can be implied, His Lordship did not believe that any breach would be so fundamental as to go to the root of the contract and thus discharge it freeing the insurer from any liability.

Hoffman L.J. (as he then was) and Sir Roger Parker agreed that a term could be implied on the basis of Willes J.’s statement to the jury in Briton[83], but without further explanation save “[...] that such a clause is merely in accordance with principle and sound authority”[84].


What their Lordships were referring to is this:
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 if there is wilful falsehood and fraud in the claim, the insured forfeits all claim whatever upon the policy [...] Per Willes J.[85].

Tangentially the court did not provide any explanation as to how the term would be implied. However, it is possible to apply this into the ratio of Liverpool City Council. First the insurance contract would appear to be incomplete without a term that expressly deals with fraud. Second an insurance contract is a common type of contract and so this condition is met. Finally is the term reasonable in relation to the parties’ expectations? In both parties cases the term that excludes the parties from undertaking fraudulent conduct would be fair and reasonable on either party.

Irrespective of the tangential issue above, it can be observed from Willes J.’s summing up to the jury that the law links “perfect good faith” with the duty not to make a fraudulent claim and emphasizing the need to protect the insurer from fraud. He also considered the consequence of a breach by indicating the forfeiting “all claim” under the policy. By this Willes J. was referring to the avoidance of the whole policy.

Whether the fraudulent claim should be forfeited under the policy or the whole policy was the next question for Hoffman L.J. and Sir Roger Parker inOrakpo.Hoffman L.J. stated in relation to the consequences for a breach of the implied term that:

I think that the insurance company should be able to trust the assured to put forward a claim in good faith. Any fraud in making the claim goes to the root of the contract and entitles the insurer to be discharged [...] But in cases in which fraud in the making of the claim has been averred and proved, I think it should discharge the insurer from all liability[86]

Sir Roger considered the question whether the claim or the whole policy should be avoided by considering the pre-contractual duties and remedies along side the post-contractual duties and remedies. He stated:

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[87]. Therefore, what can be concluded from this case is that Straughton L.J. thought a term could be implied, but the remedy he doubted, with the opinions of Sir Roger and Hoffmann L.J. to the effect that a term could be implied and the whole policy avoided.

(iii) S. 17 Defence
It is possible to mount a defence against a fraudulent claim based on section 17 of the Marine Insurance Act 1906 that states:

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.

As can be seen from this section the duties the contractual parties owe each other is one based on the utmost good faith. This section provides a remedy of avoidance to the insurer when the insured breaches this section. In the post-contractual application the duties are far narrower than in comparison to the pre-contractual position and from the insured’s view they include the duty not to make a fraudulent claim[88]. A breach of this section would allow the insurer to avoid making any future payments and recover any indemnity he has already provided. This is no more than rescission suggests, to place the parties back into a position they were in before the contract was entered, avoidable at the time of the breach.

There has been, and still remains, some confusion in this area. The first area of confusion is whether the section applies to post-contractual breach as the word “utmost” is normally associated with pre-contractual issues with what Professor Birds describes as “[...] the section acting merely as a preamble to the later specific sections on non-disclosure and misrepresentation” (Birds, 2010, p. 136).

The key authority on post-contractual good faith is the House of Lords decision in The Star Sea[89]. The issue was whether the owners of a ship were in breach of the duty imposed by s. 17 post-contract. In this case the owners, the Kollakis group, had renewed their insurance cover for a fleet of 40 vessels.The Star Seawas one of those vessels. After a severe fire in the engine room the vessel was considered a total constructive loss. A claim was made against the insurance and the insurer defended by first claiming a breach of s. 39(5) of the Marine Insurance Act 1906[90] and second claiming that there was a breach of s. 17 of the Act by failing to disclose certain information. This information referred to a report on other similarly built ships in the group that had also caught fire in a similar way. The insurer argued that the insured should have disclosed this information even after litigation had started. So this case is not concerned with fraud, but the post-contractual duties of disclosure.

The House of Lords held that the duty was not to present a fraudulent claim at common law and anything less than this would not suffice[91]. Thus, the post-contractual duties under s. 17 were greatly restricted to one of honesty as Lord Scott observed and with whom Lords Hoffman and Steyn agreed. He stated:

I would, however, limit the duty owed by an insured in relation to a claim to a duty of honesty. If the duty derives from s 17, nonetheless this limitation does not, in my opinion involve a judicial re-writing of s 17. On the contrary, it would be the creation out of s 17 of a duty that could be broken notwithstanding that the assured had acted throughout in good faith that would constitute a re-writing of the section. Unless the assured has acted in bad faith he cannot, in my opinion, be in breach of a duty of good faith, utmost or otherwise. For these reasons, I agree with Tuckey J and the Court of Appeal in concluding that the insurers’ s 17 claim cannot succeed[92].

This approach to interpreting the post-contractual duty as one of honesty was also cited by Lord Hobhouse. His Lordship cited with approval the approach taken by Roskill L.J. inPiermay Shipping Co Sav.Chester (The Michael)[93] who delivered the leading judgment. “The relevant test must be honest belief”[94]. The insurers had to prove that a fraudulent claim had been made or maintained by the insured.

However, as fraud was not at issue inThe Star Seathis therefore concluded the issue, but the House of Lords did have reservations and reluctantly concluded that utmost good faith did encompass the making of a fraudulent claim and that the remedy, statutory avoidance, would be available to an insurer who pleaded it. This was also the conclusion of the Court of Appeal inThe Mercandian Continentwhich confirmed that statutory avoidance was available to insurers for all breaches of utmost good faith, provided they could prove materiality and inducement, effectively mirroring the pre-contractual counterpart. Thus, as Professor Birds observes:

[...] the right to avoid was restricted to a case where:
(a) the fraud would have an effect on the insurers’ ultimate liability; and
(b) the gravity of the fraud or its consequences would entitle the insurers, if they wishes to do so to terminate the contract for breach[95].

(iv) The public policy defence
In The Aegeon (No. 1)[96] a ferry was damaged by fire on the 19 February 1996. The insured had warranted that they would not undertake any “hot works”, i.e. welding without the approval of the insurer. The insurer’s surveyor approved the repairs on 8 February with repair work said to have commenced on 12 February. However, two crewmembers statements discovered during the litigation process contradicted this date, in that the hot works were commenced on 1 February, thus without the insurers permission. This resulted in the insurers seeking to amend their defence in that:

• a fraudulent device had been used to advance the claim and therefore they should be entitled to avoid the claim; and
• there had been a breach of good faith entitling them to avoid the policy. The questions before the court were:
• whether there was a distinction between a fraudulent claim and a fraudulent device; and
• whether the timing of the disclosure affected the claim.

In relation to the first issue, Mance L.J. took a cautious approach due to the lack of authorities on the specific point. He did not see the necessity to divorce a fraudulent claim from a fraudulent device. He tentatively suggested:

[...] [t]o treat the use of a fraudulent device as a sub-species of making a fraudulent claim – at least as regards forfeiture of the claim itself in relation to which the fraudulent device or means is used[97].

Therefore, the common law position is the same, i.e. only avoidance of the claim, and not the policy, is permitted in both instances. Thus, the Court of Appeal permitted the insurers to plead the amended defence.

This decision significantly widens the definition of fraud by extending it to include “means and devices” and thus with it, the insurers’ possible defences. However, this decision is doing no more than reflecting the long standing position of the common law in that it will not allow someone to benefit as a result of either their crime or wrongdoing[98].

In relation to the second issue (the timing of the disclosure) occurring during the litigation process, and the Court of Appeal followed Lord Hobhouse in The Star Sea and reiterated that the parties’ rights crystallise when proceedings are issued and the Civil Procedural Rules govern the extent of disclosure and other respective dealings. Resultantly there:

[...] is no longer the need for the remedy of avoidance under s 17; other more appropriate remedies are available [...] though s 17 may influence the court in the exercise of its discretion[99].

Furthermore, the position adopted by the common law has most recently been followed inSharon’s Bakery (Europe) Ltdv.AXA Insurance UK plc and Another[100] andAviva Insurance Ltdv.Brown. In the forma case the insured gained finance from a bank using a fraudulent invoice to purchase goods. These goods were insured by AXA and when they were subsequently destroyed by fire the insured used the same fraudulent invoice to support the claim. The use of such a fraudulent device tainted an otherwise genuine claim and the insured forfeited all claim under the policy. In the latter case Aviva were being counter sued by Brown on two claims. The court held that one claim was forfeited due to fraud, but the other claim was untainted and could stand.


Reforms
The whole focus of any reforms needs to be undertaken in a coherent manner to complement the corresponding duties of good faith of the insurer towards the insured. However, there needs to be a strong anti-fraud deterrent conveyed to any potential insured fraudster. The insurers’ right to avoid the policy may have been a sufficient deterrent when the law was codified in 1906, but this, it may seem, is no longer the case. Reinterpreting the right only to avoid a claim as a matter of common law has confused many issues and the lack of clarity from the language in the Marine Insurance Act 1906 has not helped create a clear interpretation, a point made by Zurich in that the phraseology used in the Marine Insurance Act is out of kilter with the “[...] culture and lifestyle of the 21st Century”[101]. Therefore, s. 17 needs clarification, but seven of the 33 respondents to the joint Law Commission proposals believed that any reform was unnecessary. Nevertheless, the Law Commission has identified three reasons why s. 17 should be reformed:

1. The disjuncture between the common law rule and section 17 generates unnecessary disputes and litigation.
2. Increasingly, commercial law in the UK must be justified to an international audience. The UK must seek to develop insurance law in a coherent, principled and fair way if it wishes to influence wider European and international activity in the area.
3. The rules on fraudulent claims are intended to act as a deterrent, and deterrents work best if they are clear and well understood. Penalties, in particular, should be clearly set out in law[102].

If the law is to be reformed then it could do far worse than adopt statutory implied terms similar to those used in other commercial legislation such as ss. 12-15 of the Sales of Goods Act 1979. Any duty and remedy could easily be implied into insurance contract and to some extent, every duty that became statutory would render superfluous any need for good faith to be included in the contract, a point supported by the British Insurance Law Association and Beachcroft[103].


What should be the remedy?
The Law Commissions reports that all but one of the responders agreed that the correct view was that followed by the common law, i.e. forfeiture of the whole claim, but with some judicial discretion for cases involving minor exaggerations or “embellishing” as the Bar Council commented[104]. Therefore, 81 per cent of the respondees favoured the abolition of the right to avoidance and the repayment of previously made genuine claims, but there was still some support for retaining the remedy as a last resort as the ABI commented[105]. However, one comment that needs to be viewed with caution is the suggestion by QBE Insurance that “[...] in the event of a fraudulent claim, the insured should have a renewed duty to prove the validity of the other claims”[106].

This approach can be viewed as dangerous. It would effectively allow the insurer to escape their liability, and is akin to avoidance via the back door. If the evidence suffices to support a claim at first instance, then retrospectively requiring the insured to furnish greater evidence at a later point in time (when the evidence may no longer be available) because a later claim is discovered to be fraudulent, amounts to unraveling the contract placing a burden on to the insured to prove the loss was genuine which, he may still not be able to do. Thus, if anything, it is the insurers initial lack of probity and rigour that should be examined, for if their contention is accepted the next issue is how far back would the insurers be able to go? Would this be to the start of the policy or from the renewal date? Thus, it seems that the insurer would be allowing himself the scope to act almost to the state of negligence in permitting a claim in the first instance.

A remedy that has been suggested is that of termination. This would allow the insurer to terminate the cover immediately on the discovery of the fraud. However, this remedy should be exercised with caution, as the fraud would need to be proved, for there is a difference between allegation and outright proof of fraud. Otherwise if the insured has acted negligently the insurer may be too eager to make a wrongful allegation of fraud so that they are absolved of any further liability. The insurer potential for making such a rushed decision that the insured has been fraudulent is supported by the Financial Ombudsman Service who state “It might be detrimental to consumers if the law encouraged insurers to exercise the right to terminate prematurely without fully investigating an allegedly fraudulent claim”[107].

That said, the insurance industry is pressing for greater remedies and one such remedy is damages payable to compensate an insurer for their investigation into the claim. An insurer is currently liable to indemnify the insured immediately upon the harm occurring due to the “hold harmless doctrine”[108]. If the insurer suspects and ultimately proves fraud then he will no longer have to pay the indemnity. However, the insurer will have incurred costs in conducting his investigation. Nearly 70 per cent of responders supported the idea of recovering investigation expenses without limitation, even though, as the Law Commissions observes, this would amount to double recovery. The supporters of this view have a very good point. If a potential fraudster knew that they would be liable for the cost of an investigation, then they may not act fraudulently. However, as the Bar Council observed:

[...] that in most cases insurers would find it difficult to recover such damages as in our experience most fraudsters either do not have substantial means or have managed to conceal such assets as they have[109].

In a recent decision in Aviva Insurance Ltdv. Brown[110] the insured owned a semi-detached house, 13 Friern Barnet Lane in London. A company (of which Mr Brown was a majority share holder) owned No. 15 next door. This repair work to No. 13 necessitated Mr Brown finding alternative accommodation to be paid for by the insurer. He proffered No. 38 Lyonsdown Avenue, New Barnet which was his mothers house and from where he ran his office. He did not disclose this connection to the insurers, informing them instead that the house was available to rent. However, he never occupied these premises due to his wife’s objection. In the alternative he proffered No. 15. He did not disclose his interests in the company to the insurers. The insurers duly paid rent on this property and stated repair work at No. 13 until they discovered that No. 15 was “owned” by his company. The insured rang the insurer and complained about being “chased by the landlord for the rent.”

During the course of the trial the insurer made 22 allegations against the insured some of which were abandoned during the trial, but there were three main issues. The first was the insured’s connection with his company renting out No. 15 to him. The insurer wanted to treat them as one and the same person. However, as the company was a separate legal entity the insurer failed. The insurer also alleged that the insured was not been “chased by the landlord for the rent.” The court agreed that this was a lie and thus fraudulent, but this was not substantial and therefore the insurer lost in relation to this point. On the third point however, the insurer won. The insured had acted fraudulently when he stated that No. 38 was available to rent and someone other than the insured owned it. The court did accept this as fraudulent. Eder J. did not believe the insured had transferred the house into trust as there was no documentation or other evidence on which to base this stance. The insured was held to have been dishonest by the combined test inTwinsectra.

This finding of liability resulted in the insured forfeiting his claim under the common law. Resultantly he had to repay the insurer all the rental moneys and for the repairs undertaken at No. 13. The court did however allow a second claim for a skylight to stand, independently of the fraud in the first claim. Thus, this reinforces that it is only the claim and not the policy at common law that is forfeited. The insurer does not appear to have claimed the cost for their investigation, which could have been recovered. However, there is a cautionary note the insurer failed to persuade the court on all of the other grounds. Therefore, if it had not been for the issues surrounding No. 38, no substantive fraud would have been proven.


Conclusions
It is submitted that the Law Commissions do not need to suggest reforms so that an insured can be sued for damages representing the insurers expenses in investigating a suspected fraudster. The common law position inDerryv.Peekcould form the basis for an action. However, first it would be particularly embarrassing for the insurer if he failed to prove that there was a fraud once he had issues proceedings. In these circumstances the insurer would then have to pay the insured’s costs, assuming that it was not a small claims issue as well as his damages for the insured event. Furthermore, if the Law Commissions proposals in Paper 6 are anything to go by, then the insurer would also have to pay damages for the consequential loss the insured has suffered, although this is not yet the case due to the “hold harmless principle.” Thus, it would make cases likeThe Italia Expressfor the insurer would have to prove fraud and if he could not then the delay the insurer has caused and the fact that he may have to pay for the consequential loss may act as a restraint on the insurer from arbitrarily crying foul on a policy.

Second if the insured had to pay damages for an insurers cost undertaking an investigation then this would act as a further deterrent. However, it may deter an innocent insured who was afraid to claim, nervous about uncertainties that an insurer may cry foul, because they could not prove the loss[111]. This may disproportionally affect those who need the insurance the most. Therefore, careful consideration is needed before legislating as an impecunious insured would need deep pockets in order to sue an insurer if the insured believed that he was innocent, but the insurer did not accept this believing the insured was fraudulent.

The situation is uncertain. The situation is fluid but these suggestion would discourage the insured from undertaking fraudulent activities so that he should no longer think, “if the fraud is successful then I will gain, if it is unsuccessful I will lose nothing.” The Law Commissions will be undertaking further more detailed consultations before recommending any modifications to s. 17. Here it is submitted that the insured and the insurer’s duties should be stated clearly as implied terms and that these terms should be like those implied in the Sales of Goods Act 1979 whereby they should be the only terms that will govern the contract, therefore abolishing express clauses in consumer contracts to harmonise the area across the industry. However, as these issues need to be carefully considered as it would seem unlikely that any more reforms would not be considered for some time if the 1906 Act is anything to go by.



References
Birds, J. (2010),Modern Insurance Law, 7th ed., Sweet & Maxwell, London, p. 136.
Clark, M.A. (2009),The Law of Insurance Contracts, 6th ed., Informa, London, p. 896.
Eggers, P.M., Picken, S. and Foss, P. (2010),Good Faith and Insurance Contracts, 3rd ed., Lloyd’s List, London, p. 287.
Hird, N.J. (2001), “Case comment: the star sea – the continuing saga of utmost good faith”,JBL, Vol. 311 No. 314.