Extent of duty

Jane Martineau, of UK-based Henmans Solicitors, looks at the extent of the duty of utmost good faith under English law

SECTION 17 of the Marine Insurance Act 1906 provides, “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.”

On January 18 this year, the House of Lords delivered its long-awaited judgment in Manifest Shipping Company Limited v Uni-Polaris Shipping Company Limited and Others (Star Sea), in which the scope of the broad provision in Section 17 of the Marine Insurance Act 1906 was considered. This judgment follows a string of recent cases where the extent of this duty has been examined by the English courts in a post-contractual context.

One of the points that fell to be determined by the House of Lords involved the contention raised by the defendant underwriters that there was a positive duty of fair dealing and disclosure, any breach of which would amount, in effect, to constructive fraud giving rise to the Section 17 remedy of an entitlement to avoid the contract. On the facts of the case, the defendants had to contend that the duty extended up to, and included, the pursuit of any claim in litigation given the stage at which the matters on which they relied had occurred.

In his judgment, Lord Hobhouse examined the history of the concept of good faith in considerable detail, together with the remedy that it provides to the aggrieved party. He summarised the position as follows,

“…where the want of good faith first occurs later, it becomes anomalous and disproportionate that it should be so categorised and entitle the aggrieved party to such an outcome. But this will be the effect of accepting the defendants’ argument. The result is effectively penal. Where a fully enforceable contract has been entered into insuring the assured, say, for a period of a year, the premium has been paid, a claim for loss covered by the insurance has arisen and been paid, but later, towards the end of the period, the assured failed in some respect fully to discharge his duty of complete good faith, the insurer is able not only to treat himself as discharged from further liability but can also undo all that has perfectly properly gone before”.

Lord Hobhouse concluded that no principle of this breadth is supported by any authority and found that there is a clear distinction to be made between the pre-contract duty of disclosure and any duty of disclosure which may exist after the contract has been made.

In conclusion, Lord Hobhouse stated that, “Suitable caution should be exercised in making any extensions to the existing law of 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 to observe good faith”. On this basis, the judgment of the Court of Appeal was affirmed, and the duty of utmost good faith requires that, when the assured makes a claim, it should not be made fraudulently.

The courts have been called upon to consider the effect of Section 17 and the post- contractual duty of good faith in a number of other recent cases. For example, KS Merc-Scandia XXXXII v certain Lloyds’s Underwriters (see also In the Dock) undertook a comprehensive review of the authorities. The Star Sea decision in the Court of Appeal was one, and the others referred to included the following:

The Litsion Pride (1985, 1 Lloyds Rep 437) involved a claim by the assignees of a war risk policy involving a vessel that was chartered for a voyage to Bandar Khomeini during the Iran/Iraq war. The trial judge found that the owners knew that the vessel would enter the excluded zone on or about July 15, 1982, but that they deliberately did not inform the underwriters, hoping that the vessel could enter and exit the Gulf without the underwriters’ knowledge so that no additional premium would be charged. The vessel was hit by a missile and sank.

The trial judge found that the owners had forged a letter dated August 2, 1982, informing the brokers that the vessel was entering the excluded zone at 1600 hours that day. The letter was received by the brokers on August 12. The intention was to mislead underwriters. It was found that the statements made in the course of negotiating the claim were fraudulent and the claim was resisted successfully. The judge drew a distinction between circumstances when the duty of utmost good faith operated after an insurance contract had been concluded and those involving the presentation of a fraudulent claim. He found that the assured was under a duty towards the underwriter not to act in a fraudulent manner “where under the terms of the contract the assured has a duty to do something - e.g., to give information under the warranty”.

2. In Royal Boskalis Westminster NV v Mountain (1997 LRLR 523) the trial judge found that the shipowners had deliberately concealed from the insurers full details of an agreement in presenting their sue and labour claim. In the circumstances, the judge found the owners were not guilty of presenting a fraudulent claim. There were deliberate and culpable misrepresentations by the assured at the post-contract stage, but the actual claim on the policy itself was a valid one. The judge found it difficult to see where the principle would stop and stated in his judgement, “These considerations lead me to doubt that the duty of good faith with its draconian statutory remedy of avoidance is intended in a claims context to extend outside the context of fraudulent claims”.

Turning to the facts of the KS MERC-SCANDIA case, after the claimant had started proceedings against the assured, the assured produced a forged letter to assist its case for resisting service out of the jurisdiction. When the forgery was discovered by the assured’s liability underwriters, they argued they were entitled to avoid the policy because the assured had breached its duty of utmost good faith in producing the forged letter, and the assured had been in breach of its obligation to keep them informed by failing to disclose the forgery.

The claimants had obtained judgement against the assured and were seeking to enforce that against the underwriters. It was submitted on behalf of the underwriters that the assured was under an express contractual obligation to keep the insurers ‘fully advised’ in relation to any occurrence which might give rise to a claim and an implied contractual obligation of co-operation once the insurers had taken over the defence of the claim against the assured. Aikens J took the view that the duty of utmost good faith did not attach in the circumstances of this case. His reasons for this were as follows,

1. The underwriters were not being asked to take on a different risk, nor were they being asked to pay or consider a claim under the policy. The forgery related to a collateral matter rather than something that was essential to the claim.

2. The forged letter had no legal relevance to the assured’s claim on the policy itself and, if he had held otherwise, the judge took the view that he would be saying there was a disciplinary element in the law of marine insurance in relation to post-contract conduct. This approach was specifically rejected by Lord Mustill in Pan Atlantic Insurance v Pine Top Insurance.

3. The evidence does not suggest that the insurers were induced to do anything with regard to the claim under the policy as a result of the production of the July 1 letter.

For all these reasons, Aikens J took the view that underwriters were not entitled to avoid the policy for breach of the duty of utmost good faith as a result of producing the forged July 1letter. Part of the judge’s reasoning in this case seems to have been influenced by the fact that the underwriters had suffered no serious consequences in fact as a result of the contents of the forged letter.

The Star Sea judgment in the House of Lords has confirmed that the UK courts are not prepared to allow any breach of duty of utmost good faith to become a draconian remedy where it arises in a post-contractual capacity.