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Fraudulent devices and s. 12 of the Insurance Act 2015

1.       In Versloot Dredging BV and Another v HDI Gerling Industrie Versicherung AG and others [2016] UKSC 45 the Supreme Court recently held that a ‘collateral lie’ told during an insurance claim (also known as a ‘fraudulent device’) will not be sufficient to invalidate the whole insurance claim.

2.       Whilst the ratio addressed the position at common law, the Court indicated, obiter, that the position would be the same under s. 12 of the Insurance Act 2015 (the ‘2015 Act’), which is due to come into force on 12 August 2016.

The Facts

3.       A vessel suffered irreparable engine damage by the ingress of water to its engine room which was caused by a combination of crew negligence, third party negligence and equipment defects.

4.       One of the key witnesses in support of the claim provided a statement in which he stated that the bilge alarm had sounded but the crew had been unable to investigate or deal with the leak because of the rolling of the vessel in heavy weather.

5.       The collateral lie came in that he explicitly stated that members of the crew had informed him that this was the position and Popplewell J found this to be a “reckless untruth” at first instance. His Lordship held that the motivation for such a lie was frustration with the delay in payment by the insurers and concern because the individual had been advised that the insurers might have had a valid defence under the Inchmaree clause if he admitted that the vessel’s condition could have been a factor.

6.       However, his Lordship continued to hold that the lie was irrelevant to the merits of the claim because the proximate cause was a peril of the sea, namely the fortuitous ingress of seawater through the sea inlet valve during the voyage such that the Inchmaree clause had no application to this peril. His Lordship thus held that the owners had a valid claim regardless of whether or not the crew had failed to act on the bilge alarm but felt constrained by precedent to hold that because there had been fraud in the presentation of the claim the entire claim failed. The Court of Appeal upheld this judgment.

The Decision

7.       Lord Sumption opened his judgment by distinguishing three situations of dishonesty that may arise in the course of an insurance claim:

7.1.    The whole claim has been fabricated.

7.2.    A genuine claim where the amount has been exaggerated.

7.3.    The entire claim may be justified, but the information given in support of it may have been dishonestly embellished.

8.       This case was concerned solely with the third situation; that of the ‘collateral lie’ which his Lordship defined at §1 as:

“a lie which turns out when the facts are found to have no relevance to the insured’s right to recover. The question is whether the insurer is entitled to repudiate a claim supported by a false statement, if the statement was irrelevant, in the sense that the claim would have been equally recoverable whether it was true or false.”

9.       Further, Lord Hughes noted the concept of a ‘fraudulent device’ at §51:

“The issue in this case has been whether that rule extends also to bar the claim where the insured has not invented or exaggerated the claim but has employed what has been termed a “fraudulent device”. By that, in this special context, is meant a lie or other fraud in the presentation of the claim to the insurers, in a case where the underlying claim is in fact good in the amount claimed. Typically the fraudulent device is bogus evidence of some kind advanced in support of the claim in order to bolster it... I gratefully adopt Lord Sumption’s expression, “collateral lie” to describe this situation. In the vernacular, the situation contemplated might be described as the policyholder “gilding the lily”.”

10.     The prior common law position was that the entire claim failed it contained any element of fraud, including fraudulent devices, and was a product of the duty of good faith which applied to all insurance contracts under s. 17 of the Marine Insurance Act 1906.

11.     However, Lord Sumption, at §23 – 26, held that the fraudulent claims rule did not apply to situations of a collateral lie because:

11.1.  It is not a precondition of the insurer’s liability that a claim should be made upon them; rather the right to indemnity arises as soon as the loss is suffered.

11.2.  In this context, there is an obvious and important difference between a fraudulently exaggerated claim and a justified claim supported by collateral lies.

11.3.  Where a claim has been fraudulently exaggerated, the insured’s dishonesty is calculated to get him something to which he is not entitled. The reason why the insured cannot recover even the honest part of the claim is that the law declines to sever it from the invented part.

11.4.  The policy of deterring fraudulent claims goes to the honesty of the claim, and both are parts of a single claim. The principle is the same as that which applies in the law of illegality. The courts will not sever an agreement affected by illegality into its legal and illegal parts unless it accords with public policy to do so, even if each part is capable of standing on its own.

11.5.  However, the position is different where the insured is trying to obtain no more than the law regards as his entitlement and the lie is irrelevant to the existence or amount of that entitlement.

11.6.  In this case the lie is dishonest, but the claim is not. The immateriality of the lie to the claim makes it not just possible but appropriate to distinguish between them.

12.     As to the necessary connection between the lie and the claim to bring it within the fraudulent device exception, Lord Sumption held that the test was that of materiality in the sense a lie was collateral when it was it did not affect the insured’s right to recover. This was to be distinguished from materiality in the pre-contractual, disclosure context where materiality is defined as that which would affect the decision making of the prudent insurer in concluding the insurance policy.

13.     Lord Hughes summarised the distinction between these two senses of materiality at §91:

“The important difference between the pre- and post-contract (claim) stages lies in the power of decision in the hands of the insurer. Pre-contract, he is free to take or to refuse the risk. A failure of disclosure or false statement deprives him of the opportunity to consider something. If it might have affected his decision, it is “material”. And if he had known the truth, he would have had a perfect right to refuse to issue the policy. Post-contract, the insurer has no such freedom of choice. If the claim is good, he is legally obliged to pay it. A lie told in the making of the claim may well affect his handling of the claim, or the speed at which he pays it, or the inquiries which he calls for, but it can make no difference to his liability to pay. It may well be material (relevant) to his behaviour, but it is immaterial (irrelevant) to his liability. So “materiality” means something different at the two stages. The question is: material to what? For this reason, I respectfully agree with Rix J’s conclusion that the concept cannot simply be transposed to the post-contract situation. It does not migrate unchanged between the two stages, any more than the duty of good faith does”

14.     At §92, Lord Hughes agreed with Lord Sumption’s test of materiality:

“It is therefore possible to say, as Lord Sumption explains, that materiality — used in the different sense of relevance to liability — provides the answer to the issue in the present case. The collateral lie is immaterial to the liability of the insurer. In analysing the issue in that way one is, in a sense, re-stating the question: does a collateral lie defeat the claim? But one is also focussing on the critical difference between the collateral lie and the false or exaggerated claim. The collateral lie is certainly told with the aim of improving the position of the liar, but in fact and in law it makes no difference to the validity of his claim whether it is accepted or found out. The false or exaggerated claim is also made with the aim of improving the position of the liar, but if accepted it provides him with something to which he is not entitled in law.”

15.     Finally, their Lordships noted the submissions on Article 1 Protocol 1 of the European Convention on Human Rights but given their conclusion on the facts, such issues did not arise and thus they declined to comment. Lord Clarke and Lord Toulson agreed with the majority.

16.     Lord Mance, however, dissented primarily on the basis of policy; namely, that the relationship between insurer and insured is a special one of good faith.

17.     Further, there exists a long, if limited, line of authority in support of the proposition that fraudulent devices are to be included in the stringent legal response to fraudulent claims, which serve as a necessary and justified deterrence to insurance fraud.

18.     In this regard, his Lordship emphasised that the rule encourages integrity and deters fraud in the claims process, which would otherwise be distorted through the time and cost involved in unveiling the fraud and attempting to ascertain its true implications

19.     Finally, his Lordship also disagreed with the majority on the point in time at which materiality should be considered stating that it should be considered at the point when the fraud is made, not what a court would consider material many years later, on the basis that lies only make sense in their context; to hold otherwise overlooks (a) the obvious imperative of integrity on both sides in the claims process and (b) the obvious reality that lies are told for a purpose, almost invariably as here to obtain the uncovenanted advantage of having the claim considered and hopefully met on a false premise.

Commentary

20.     The majority’s test of materiality may prove problematic in practice:

20.1.  Given that the relevant point in time to apply the test is at trial, it will be uncertain whether or not a lie is material until the fullness of the evidence has been considered and even at that point it may not be possible to predict what view the court will take of that evidence. This will render settlement unlikely, especially given that the penalty for the insured is forfeiture of the whole claim.

20.2.  It is difficult to predict how this will apply to situations where there are numerous heads of loss only one of which has been pursued fraudulently and the fraudulent claim is immaterial to the other heads of loss:

20.2.1. On the one hand, the insured could be viewed as seeking to obtain something to which it was not entitled, namely another head of loss.

20.2.2. On the other hand, the lie is entirely immaterial to the liability under the other, genuine, heads of loss such that, as to those heads of loss, the insured was not trying to claim more than he was entitled to.

20.2.3. In my view, it is likely that the court would hold that the entire claim was fraudulent on the basis that it falls within the line of authority on the exaggeration of loss but it is certainly arguable that the rule on exaggeration should be confined to those circumstances where the quantum of a particular head of loss is exaggerated and that the rule should not apply in light of this new test of materiality.

20.3.  It is unclear whether or not, as a matter of practice, there will be a de minimis rule applicable to material lies to ensure consistency with the rule on fraudulent exaggeration. It may be that future courts hold that the lie was material, in the sense that it sought to effect liability, but was so small as to be regarded de minimis and will not invalidate the claim.

21.     As a result of the difficultly in applying the test of materiality, it is likely to take longer to conclude insurance claims which raises difficult questions regarding the implied term that all insurance claims will be paid within a reasonable period of time (as to be implied into all insurance contracts next year under the Enterprise Act 2016):

21.1.  It is unclear whether an insurance company would be justified in taking a long period of time attempting to prove that a lie is material to the claim.

21.2.  This is especially difficult because the majority held that the lie is only to be assessed at trial with the fullness of evidence such that, presumably, an insurance company could be regarded as justified to hold out to trial without settlement to see whether the lie was truly collateral or not.

21.3.  The irony for the insured therefore could be that in telling a collateral lie in an attempt to speed up the process, as was the motivation in this case, their conduct leads to further delay in circumstances where the insurer may be less accountable for that delay under the implied term.

22.     The judgment forms part of the general shift towards a more insured-friendly regime, as seen in the Insurance Act 2015 and the Enterprise Act 2016, and may lead to higher premiums.

23.     As to the court’s ability to police fraud following this judgment:

23.1.  The key sanction is likely to be costs but this will be interesting to apply because it will be the successful party, the insured, that will be punished in costs. The sanction is likely to be that they obtain no costs or, whilst they may be entitled to their costs in relation to the genuine claim, they will have to pay those costs relating to the insurer’s enquiries into their collateral lie. This is a slightly odd situation because ordinarily costs are used to punish the unsuccessful party where they have behaved poorly in the conduct of the dispute such that the successful party obtains indemnity costs or a wasted costs order. This shift in dynamic is likely to make negotiating settlement more difficult.

23.2.  The court noted that there is limited prospect of being prosecuted and thus the criminal law is unlikely to play a significant role.

23.3.  As noted above, the court may take a more sympathetic view of the insurer’s conduct in handling the claim such that they will be less inclined to find a breach of the implied term to pay within a reasonable period of time, as introduced by the Enterprise Act 2016.

24.     In conclusion, it is easy to sympathise with an insured that tells a collateral lie with a view to expediting payment; however, once we move away from having a clear rule that fraud avoids a claim, practical difficulties arise and it is perhaps fortunate that, in the words of Lord Mance, this is a “relatively rare case”.

Andrew Dinsmore

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