If it is in bad faith for an insurer to act on a prima facie right to avoid because of non-disclosure, then the question as to whether an exercise of a right to avoid could be invalidated by the insurer’s bad faith will have to be envisaged. In the context of marine insurance, the duty of good faith was first codified by statute, which that, “[a] contract of marine insurance is 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. ”
This quote from the Marine Insurance Act or MIA is generally considered to be a precise statement of the common law’s stance in respect of good faith, and consequently, this duty applies to all insurance contracts. In Leen v. Hall and in Banque Keyser Ullmann SA v. Skandia (UK) Insurance Co Ltd it was held that good faith applies in equal measure not only to the insurer but also the insured. The duty of good faith in English insurance law has two basic elements, namely, a duty to desist from making material misstatements and (b) a duty to disclose all known material facts.
Duty to Disclose It is the bounden duty of the assured to divulge to the insurer, before the conclusion of the contract, every material circumstance known to the assured and in this connection it is considered that every circumstance, which in the ordinary course of business, ought to be known to the assured is known, otherwise the insurer may avoid the contract . While this seems to only impose a duty on the assured, the provision has been interpreted to apply to both parties to the insurance contract.
In Carter v. Boehm , it was held that both parties to an insurance contract are duty bound to adhere to the principle of good faith. Subsequently, courts have made this principle applicable to every level of material non-disclosure. However, the public and the judiciary have expressed the concern that this principle has been applied to excess and this has resulted in the courts opining that a change in necessarily required.
One of the concerns to be addressed is whether change would revert the situation back to the principle of aliud est celare; aliud tacere, which would make it possible for a distinction to be drawn between deliberate concealment and misrepresentation or bad faith and ‘innocent’ or good faith, although, mistaken non-disclosure, utilizing the principle of good faith from the insurer to the insured as the vehicle.
Section 18(2) of the MIA states that “[e]very circumstance is material which would influence the judgment of a prudent insurer in fixing the premium, or determining whether he will take the risk. ” Via the test for ‘materiality’ as defined in Lambert v. Cooperative Insurance Society Ltd. , the insured has to disclose material facts, irrespective of whether he considers reasonably or unreasonably those facts to be material. In the Lambert case, the court held the non-disclosure of certain previous criminal convictions was a material fact .
The facts of the case in Pan Atlantic Insurance Company Limited v. Pine Top Insurance Company are that during 1977and 1982 Pan Atlantic Insurance Company Limited or the Pan Atlantic wrote a quantity of direct long term (tail) American liability insurance. In 1982 a contract of reinsurance was entered into between Pan Atlantic and Pine Top Insurance Company Limited (Tine Top’). In relation to the years 1977 and 1979 Pan Atlantic’s Casualty Account had been reinsured with other insurers for excess of loss above a certain figure.
Pine Top became the re-insurer in respect of this cover for the 1980 policy year and later renewed for two subsequent years. A dispute arose that the losses were greater than had been disclosed, and that this had been known to the Plaintiff. It was held that, material circumstances requiring disclosure under the Act were such circumstances as would affect an insurer’s mind and whether it functioned as an inducement to the insurer to enter into the policy.
The entitlement for avoiding a contract of insurance or reinsurance on the ground of non-disclosure requires that the insurer must demonstrate both that the undisclosed fact was material and that such non-disclosure induced the contract. To be material a fact need not have a decisive influence on the mind of the prudent underwriter. The test is as stated in subsections 18(2) and 20(2) which relate to non-disclosure and misrepresentation respectively and which set out the common law principles relevant to non-marine and marine insurance.
The material non-disclosure or misrepresentation must induce the contract. It is not sufficient that the non-disclosure or misrepresentation is material. “. . . there is to be implied in the Act of 1906 a qualification that a material representation will not entitle the underwriter to avoid the policy unless the misrepresentation induced the making of the contract, using “induced” in the sense in which it is used in the general law of contract” and “in practice the line between misrepresentation and non-disclosure is often imperceptible.
” Therefore, merely establishing that a prudent insurer would have been affected by full and accurate disclosure is insufficient and that it was necessary to establish that the inducement was concomitant to a misrepresentation or non-disclosure. Influence of the Drake case on the Duty of Good Faith Although, the case of Drake v. Provident does not alter the composition of the duty of good faith or the test for materiality, it nevertheless, brings forth inferences for the remedy available the moment duty has been breached and for the concept of knowledge.
The only remedy as per statute or as available at common law is recission of the. This remedy is considered to be biased as it favours the insurer and not the insured, because under normal conditions the insured will be disinclined to rescind the contract and the maximum benefit that the insured can obtain is the recovery of the insurance premium. If the duty of good faith has been ignored or the insured has made an innocent non – disclosure, then as per the provisions of Section 17 of the Marine Insurance Act of 1906, the insurer has a prima facie right to avoid a contract.
Thus, the ruling in Drake made it possible to contemplate an equitable bar to the right of recission in insurance contracts, thereby enabling the courts to consider all the circumstances before deciding at to whether the remedy is just and does not produce unnecessary hardship. The English insurance law, in the past, has frequently attributed the heavier obligation to the assured holding that the assured had access to the necessary information, and was more likely to breach the duty of good faith. The ruling in Drake v.
Provident considered and favoured the possibility that the insurer could be thwarted by the doctrine of good faith from exercising the right to avoid where a lack of good faith in respect of a particular claim was demonstrated or in avoiding the policy. Breach of the duty of good faith does not require fraud, intentional non-disclosure, or misrepresentation; innocent misrepresentation and non-disclosure are sufficient. In Banque Financiere de la Cite v. Westgate Insurance Co Ltd, Steyn J held that the principle of good faith, while observing good faith abstained from bad faith.
The decision in Drake brought forth the fears that a principle of bad faith may develop in English law. Insurance contracts are formulated in a manner that promotes good faith and prevents fraud. An abuse of rights is contrary to good faith and constitutes bad faith. The law of bad faith was based on the perception that the parties to insurance contracts were not on an equal footing in respect of bargaining power and that the insurer was in the stronger position in this respect.
Despite the contention of a few authorities that bad faith claims are necessary to keep insurers accountable; nonetheless, moderation is essential in order to enable insurance companies to effectively examine doubtful claims and combat fraud, without fear of litigation. In President of India v. Lips Maritime Corporation the House of Lords held that there is no action in damages for a failure to pay damages, hence, if an insurer acts in bad faith the insured can only claim a return to the position in which he would have been had things proceeded as they should have and any claim for damages in excess of this would meet with failure.
Moreover, the English Court held that insurance claims constitute claims for damages. In Rookes v. Barnard, Lord Devlin defined the three classes of a case wherein it would be possible to award exemplary damages. These are, first, cases where the government representatives have taken oppressive, arbitrary or unconstitutional action. Second, where it is the intention of the defendant to make such profit as exceeds the compensation payable to the Claimant. Third, cases for which express statutes that authorize such damages are in place. Therefore, in instances of bad faith there will be no award of exemplary damages.
The fact is that English courts have taken cognizance of the fact that insurers act in bad faith. Subsequent to the decision in Drake v. Provident the insured can bring actions and if they are able to establish that the insurer acted in bad faith, the insurer will not be able to avoid the policy. However, as the English Court in general does not award damages to insureds and awards exemplary damages under very limited circumstances, the development of a punitive damages system is unlikely in England and Wales. This can be attributed to the fact that the insureds are already compensated through the process of claims and costs.
The Drake case has served to illustrate that the English Courts are well aware of the need to properly apply the principle of good faith to insurers as well as insureds and acting on such awareness. However, the courts attempts in this direction are greatly hampered by the existing case law on the doctrines of recission and damages, which they are reluctant to change. Consequently, despite the path breaking decision in the Drake case, no realistic prospect of any damages remedy against insurers for breach of the duty of good faith is possible.