Good faith: sink or swim – the impact of the Supreme Court’s decision in Versloot

On 20 July 2016, the Supreme Court handed down its long awaited judgment in Versloot Dredging v HDI Gerling Industrie Versicherung AG, which has since been described by insurance industry luminaries as “a blow for honest customers” and an “emasculation of the Insurance Fraud Taskforce”.

The facts

A claim was made under a marine insurance policy following seawater damage to a ship’s engine. It was common ground that the loss was genuine but the cause of the flooding was unclear. If the ship had been unseaworthy there would be no cover so insurers embarked upon in-depth investigations. Frustrated by the delay and in a deliberate attempt to persuade insurers to resolve the claim expeditiously, the insured told insurers that the bilge alarm had sounded but was ignored. That supported the theory that the alarm had sounded and the ship was seaworthy.

The statement confirming that the bilge alarm had sounded was a lie but the theory as to how the seawater entered the ship was indeed correct.

The decision

At first instance, and in the Court of Appeal, it was held that the insured’s statement as to the bilge alarm sounding was a fraudulent device ( “information provided by an insured which is dishonestly embellished, because the insured was unaware of the strength of the claim or was of the view that it would speed up payment and reduce any hassle”) and as a result the claimant had forfeited the claim: the fraudulent claim rule applying equally to fraudulent devices and claims.

However, the majority in the Supreme Court drew an important line between a claim which was fabricated or a genuine claim that was exaggerated and the use of fraudulent devices. The former are fraudulent claims, the consequence of which is forfeiture of the claim. In the latter case, the claim is not fraudulent and therefore will be covered.

Lord Sumption described the term “fraudulent devices” as “an archaic term” and preferred to use “collateral lies”, which he defined as a “lie that turns out when the facts are found to have no relevance to the Insured’s right to recover” or alternatively “the lie is dishonest, but the claim is not”.

In this case the lie about the bilge alarm was irrelevant to the merits of the insurance claim and so the Supreme Court allowed the claimant’s appeal.

Implications

This judgment consigns fraudulent devices to legal history and importantly limits the term “fraudulent claim” in section 12 of the Insurance Act 2015, which comes into force on 12 August 2016.

It is also the “final nail in the coffin” of the concept of good faith in insurance contracts. Lord Mance in his dissenting judgment reminded his brethren about the basis of the insurance contract:

“The relationship of insured and insurer is a special one, in relation to which good faith or uberrimae fidei has long been fundamental … rightly because of the general imbalance in information and control and the significance of moral hazard in insurance relationships. Insurance fraud is common place, often regarded as a victimless crime in relation to which insurers are fair game. Of course, insurers do not always pay claims as speedily as would be desired, but that is not an excuse for fraud, and is something for which a separate remedy is under current legislative scrutiny.”

Lord Mance was firmly of the view that the majority in the Supreme Court had wrongly conceptualised fraud and considered it from the perspective of hindsight:

“Abolishing the fraudulent devices rule means that claimants pursuing bad, exaggerated or questionable claims can tell lies with virtual impunity. The same logic governs fraudulent devices as fraudulent claims generally. It is, as Lord Hobhouse said in The Star Sea ‘…simple. The fraudulent insured must not be allowed to think: if the fraud is successful, then I will gain; if it is unsuccessful, I will lose nothing’”.

It seems that in considering the specific circumstances of the claim before them, the majority overlooked the increasing problem the insurance industry faces in relation to fraud (currently estimated at about £1.32 billion by the ABI). Any dilution of the remedies available to insurers will only increase that problem and at the same time fly in the face of Government policy, which demands that the insurance industry tackles fraud more aggressively.

This judgment at best will have cost implications for insurers whose investigations will have to go further than establishing an insured is lying during the claims process but at worst provides an insured with the ability to lie with impunity.

Interestingly Lord Mance concluded:

“In the light of the majority judgment, insurers will no doubt be advised about whatever may be the potential merits of making express in future whatever understanding they have, or action they may wish to take, regarding the effect of fraudulent devices, as and when such are discovered to have been used by an insured in the claims process”.

This is a clear signal to insurers and underwriters that if they wish to maximise their protection against fraud then they will have to create specific contractual obligations for an insured following a loss and during the claims process.

While insurers and underwriters will have reviewed their policy wordings prior to the commencement of the Insurance Act 2015, it will be prudent for them to reconsider their exposure to fraudulent claims and specifically include in their wordings a term to the effect that the making of any false statement or declaration in support of a claim will result in the forfeiture of that claim.

Read the full judgment here.