Are non-disclosure exclusion clauses soon to be a thing of the past?

A recent decision from the Technology and Construction Court, Mutual Energy Ltd v Starr Underwriting Agents Ltd, looked at the interpretation of an exclusion clause relating to non-disclosure. We consider the decision and look also at the remedies that would be available to insurers were the decision to have been handed down after the Insurance Act 2015 comes into force on 12 August 2016.

The facts

The defendant insurers (D) insured Mutual Energy Ltd (M), who operated an interconnector that provided a link between the electricity systems of Scotland and Northern Ireland (the Link). The Link failed once in September 2010 and twice in 2011. M submitted claims under their policy with D for £41 million. D argued that they were entitled to avoid the policy on the basis of a non-disclosure relating to M’s knowledge of problems with the Link’s cable at the time of construction, which could cause system failures. D did accept that the non-disclosure had not been dishonest because M had been of the honestly held belief that the facts did not need to be disclosed.

The current law

Until 12 August 2016, regardless of whether the non-disclosure is innocent or negligent, an insurer may avoid the policy from the beginning, treating it as if it never came into existence. However, it is not unusual for a policy to include a clause that limits this right to instances where the non-disclosure has been fraudulent only.

The clause in M’s policy

By way of the non-disclosure clause, not all of which is necessary to set out here, D agreed not to rely on the common law right of avoidance in the event that the risk was not adequately disclosed “unless deliberate or fraudulent non-disclosure…is established in relation thereto”.

Ds’ arguments

D accepted that the non-disclosure was not dishonest, because M’s decision not to disclose the information was driven by the fact that it considered it not necessary to disclose as opposed to any dishonest intent to conceal the information. However, D argued that this nevertheless amounted to a deliberate non-disclosure because M had taken a conscious decision not to disclose the information, albeit based on an honest but mistaken belief that it was not a material fact. In making such an argument, D argued that the words “deliberate” and “fraudulent” had to be interpreted separately with the result that D could avoid the policy if there were a deliberate, albeit innocent, non-disclosure without any element of dishonesty.

M’s arguments

M argued that the two words should be read together and that “deliberate non-disclosure” also required an element of dishonesty. In other words, D could only avoid the policy if M took the decision not to disclose the information to D in circumstances where M knew that it was a material fact that should be disclosed to D. Such a decision could not be considered an honest mistake.

The decision

Coulson J agreed with M and held that the words “deliberate or fraudulent non-disclosure”, read together, require an element of dishonesty. While this issue had not been considered by the courts before in the context of non-disclosure, the judge relied on a variety of factors in reaching this conclusion, including reviewing guidance from the Financial Ombudsman Service (albeit persuasive only rather than binding).

One of the biggest factors, however, appears to have been the judge’s wish to interpret the clause so as not to flout commercial business sense. To have found in D’s favour would have resulted in D being in a position to avoid the policy for negligent non-disclosure, thus contravening the whole purpose of the clause.

In addition, it could be argued that D were trying to have their cake and eat it – they had suspicions that the non-disclosure was fraudulent, but did not have sufficiently robust evidence to satisfy the burden of proof. Instead they sought to avoid the policy by construing the clause in the way that they did.

Insurance Act 2015

It will be interesting to see whether such clauses will be included in policies written after the implementation of the Insurance Act 2015 on 12 August 2016, given that the remedies set out in the Act are intended to provide the protection that these clauses seek to provide. In some respects, it might be in insurers’ interests to remove such clauses.

On the facts of the present case, the clause prevented D from relying upon the clause because M’s non-disclosure was an honest mistake. Absent the clause, if the same issue arose once the Act is in force, insurers could rely on clause 4 of Schedule 1 of the Act, which entitles insurers to avoid the policy and refuse all claims if the insurer would not have written the policy on any terms. This may achieve the outcome that D were seeking.