Utmost Good Faith in Insurance Contracts

Introduction-

Insurance contracts are a special class of contracts which are guided by certain basic principles like those of utmost good faith, insurable interest, proximate cause, indemnity, subrogation and contribution. As such, an insurance contract is generally a combination of more than one of these principles and no single principle can be used at one time. The rest is dependent on the contract between the parties. These principles are mostly guided by common law principles from which they have developed. They have also been modified by principles of contract and by statutes as in the case of the Marine Insurance Act, 1963 which has to a certain extent relaxed the basic principles of insurance law.

General Principle of Utmost Good Faith

Out of all the abovementioned principles, the principle of utmost good faith remains one of the most important doctrines underlying the law of insurance. In Banque Finaciere de la Cite v. Westgate Insurance Co. Ltd., (1989) 2 All ER 982, it was held that-The duty of disclosure is neither contractual, nor tortuous, fiduciary or statutory in character but is founded on the jurisdiction originally exercised by the courts of equity to prevent impositions.

The term good faith has been mentioned in the Indian Penal Code and it signifies good intention and due care and caution. However, this principle under insurance law needs to be examined in the contractual context. In every contract in general, both parties owe no positive duty toward each other beyond showing ordinary good faith. This emanates from the right of every person to know about every material fact associated with the subject matter of the contract and there is no escape to this. This follows from the maxim Caveat Emptor or buyer beware as under the Sale of Goods Act. It means that each party must be given a reasonable opportunity to make independent enquiries about the subject matter in question so that they may take a decision. Thus, all material facts must be disclosed or made available to the party so that he or she may reasonably enquire about the same. This further puts a duty on the party making the subject matter accessible to the person enquiring, not to play fraud or misrepresent the same, else it would be hit by S.19 of the

Indian Contract Act, making the contract voidable at the option of the innocent party. But, S.19 also clarifies that misrepresentation or even silence amounting to fraud will not entitle a party to avoid the contract if he had the means of discovering the truth with ordinary diligence and did not do so. Hence, there must thus be free consent and the parties must understand the same things in the same sense.

The burden of proof to show non-disclosure or misrepresentation is on the insurance company and the onus is a heavy one. The duty of good faith is of a continuing nature in as much no material alteration can be made to the terms of the contract without the mutual consent of the parties.

CASES-

1. Brownlie v. Campbell, (1880), 5 App Cas 925-

If one knows any circumstance at all which may influence the underwriters opinion as to the risk he is incurring, there is an obligation to disclose that which one knows and the concealment of any material circumstance whether you thought of it as being material or not, avoids the policy.

2. Rozanes v. Bowen, (1928), 32 L.I.L.R. 98

The principle of utmost good faith was laid down here. It was said that since it is to be presumed that the underwriter knows nothing and the assured knows all, the latter must disclose the same. Thus, an insurance contract is a contract uberrima fides.

Good Faith expected from both parties-

Good faith is expected from the insured or assured as well as the insurer. It is the buyer's duty to disclose all facts related to the risk to be covered. Similarly, it is the insurer's duty to inform the insured of all the terms of the contract. However, it is generally the assured person on whom there is a bigger duty to disclose. This is primarily because very often the insurer has to depend upon what details the insured mentions in his form. If the insured gives wrong details or details of goods which are actually not in existence, the insurer may end up paying for the wrong claims in the future. The insurer faces a lot of problems trying to verify all such details, even though the advent of technology has made the task comparatively easier now a days. Wrong information given not only affects the insurer but also the other people involved in the insurance pool whose premiums may be wrongly utilized to satisfy the claims. It is therefore an implied condition or principle of insurance that the Assured be required to make a full disclosure of all material particulars within his knowledge about the risk. Further, considering the increase in new businesses in which insurance is being taken, it becomes mandatory for the assured to inform the insurer if there are any alterations or changes to the business which increases the risk during the validity of the policy and get his permission. If no disclosure is made, the insurer has every right to avoid the contract.

CASES:

1. United India Insurance Co. Ltd. v. MKJ Corpn., (1998) 92 Comp Cases 331 (333)

Just as the insured has a duty to disclose, it is the duty of the insurers and their agents, to disclose, all material facts within their knowledge, since obligation of good faith applies to them equally with the assured.

2. Banque Finaciere de la Cite v. Westgate Insurance Co. Ltd., (1989) 2 All ER 982

In this case, the plaintiff bank had agreed to lend some 30 million pounds securities in the form of some gemstones and some credit insurance policies. The gemstones when valued did not prove to be worth much. So, the bank sought to rely on the insurance policies. The policies had been brokered by a major firm of brokers who resorted to a series of false covers due to inability to obtain full cover. On making claims under the policies, the bank discovered severe shortage in cover. It was held that the insurers were under an obligation to disclose the same. It was also held that the only remedy available to the insured is to rescind the policy and claim the premium. No other damages may be awarded.

3. Joel v. Law Union, 77 LJKB 1108

The duty to show good faith falls on the insured as well as the insurer to an equal degree in all types of insurance contracts.

4. Anstey v. British Natural

The insurer must inform the insured about the terms and conditions of the policy that is going to be issued to him and must strictly conform to the statements in the prospectus if any.

What is a material fact?

Another problem arises as to the definition of the term material fact. What may be material for one may be immaterial for the other and vice-versa. But, generally speaking, a material fact is one which affects the judgmental capacity of a person. It must be such that a different consequence would have occurred had it not been disclosed. The following cases illustrate the different theories evolved by the judiciary regards this.

CASES:

1. Marine Life Insurance Co. v. Ontario Metal Products, 94 LJPC 60

The test of materiality is the judgment of the prudent insurer and it is not what is material in the opinion of a reasonable assured.

2. Reynolds v. Phoenix Assurance Co. (1978) 2 Lloyds Rep 440

The test is whether the circumstance in question would influence the prudent insurer and not whether it might influence him.

3. Lindenau v. Desborough, (1828) 8 B & C 586

The question is whether any particular circumstance is infact material and not whether the proposer believed it to be so.

4. St. Paul Fire and Marine Insurance Co. (UK) Ltd. v. Mc Connell Dowell Constructors Ltd, 45 Con LR 89

Two major questions were decided in this case. The first was the test of materiality according to which the fact in question must have been of interest to a prudent insurer. Secondly, as regards the presumption of inducement, it was held that the test would be satisfied if the insurer could show that he was influenced in whole or in part by the assureds misleading presentation of the risk.

The Prudent insurer test has been adopted in S.149(6) of Indian MV Act,1988 and S. 149(5) of English Road Traffic Act, 1972.

Evolution of the doctrine under Common Law- (mention citations of cases used)

The contract of insurance is thus one of uberrima fides or of utmost good faith where the duty of disclosure lies on both the parties. A greater duty is cast on the assured to make known to the insurer till the date of validity of the policy about all such material facts connected with the subject matter of the insurance which the insurer doesnt know or is not deemed to know. A failure to disclose such fact, even if done innocently, will entitle the insurer to avoid the contract within a reasonable time period.

The basis of this rule can be found in the famous case of Carter v. Boehm (1766) 3 Burr 1905, where L. Mansfield stated that Insurance is a contract of speculation. The special facts upon which the contingent chance is to be computed lie most commonly in the knowledge of the assured only; the underwriter trusts to his representation and proceeds upon confidence that he does not keep back any circumstance in his knowledge to mislead the underwriter into a belief that the circumstances do not exist. The keeping back of such circumstances is fraud, and therefore the policy is void. Although the suppression should happen through mistake, without any fraudulent intention, yet still the underwriter is deceived and the policy is void; because the risque run is really different from the risque understood and intended to be run at the time of agreement. . . . The policy would be equally void against the underwriter if he concealed. ... Good faith forbids either party, by concealing what he privately knows to draw the other into a bargain from his ignorance of the fact, and his believing the contrary.  Clearly so, L. Mansfield here talks only about the obligation of the insured towards the insurer at the time of making of the contract. This statement fails to cover such disclosures as are ought to be made by the assured after the completion of the contract and during the validity of the policy.  The facts of this case were that a policy was created against the loss of Fort Marlborough on its being captured by a foreign enemy. The policy was for the benefit of George Carter, the Governor of the Fort. It was alleged by the insurer that weaknesses in the fort and possibility of attack by the French must have been disclosed. The jury decided in favour of the plaintiff and held that as it may be presumed that the underwriter knows nothing about the subject matter in question, it is the duty of the insured to disclose all material circumstances which may greater the risk involved.

The Marine Insurance Act, 1906 in England also incorporates within it the principle of utmost good faith. Sections 18-20 of the Act address the pre-contractual duty of good faith at more length. Section 18 deals with disclosure by the assured, Section 19 with disclosure by agents to insure, and Section 20 deals with misrepresentation.

Another important question which arises is does the duty of utmost good faith continue even after the contract is made? Here came the landmark case of Black King Shipping Corp. v. Massie (The "Litsion Pride"). In this case, the assured ship owners failed to disclose to the underwriters that the vessel was about to enter a dangerous part of the Persian Gulf so as to avoid having to pay a higher war risks premium. The vessel was struck by an Iraqi missile, and the owners then presented a fraudulent claim by lying to the underwriters about the vessel's position at the time of the casualty. The court held that the underwriters were entitled either to avoid the policy for fraud or deny the particular claim.

In Manifest Shipping Co. Ltd. v. UniPolaris Insurance Co. Ltd. (The "Star Sea"), 10 Greek ship owners sued underwriters under a marine policy following the constructive total loss of their vessel as a result of a fire. The underwriters raised two defences. First, they relied on Section 39(5) of the Marine Insurance Act, which provides a defence to liability where, "with the privity of the assured, the ship is sent to sea in an unseaworthy state." The underwriters alleged that the owners had "blind-eye knowledge" of the unseaworthy condition of the vessel namely, defective funnel dampers-which meant that the engine room could not be sealed, and the fact that the fire extinguishing system had been poorly maintained and was not working properly. Second, they relied on Section 17 of the Act, alleging that the owners were in breach of the duty of utmost good faith by failing to disclose the facts relating to an earlier fire aboard another vessel, Kastora, at the time the underwriters' solicitors were investigating the Star Sea claim. It was held that utmost good faith is a principle of fair dealing which does not come to an end when the contract has been made.  Lord Hobhouse proceeded to distinguish between a contractual obligation of good faith in the performance of a contract, the primary remedy for breach of which was damages, and the legal duty imposed by Section 17. He said that the right to avoid under S.17 operates retrospectively and allows a party to rescind the contract ab initio.  Thus, where a fully enforceable contract has been entered into insuring the assured, but later, towards the end of the period the assured fails 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. Thus, there is a duty to disclose on the insured even after the contract is completed.

In K'S Merc-Scandia XXXXII v Lloyd's Underwriters (The "Mercandian Continent"),20 the claimants were the owners of a vessel which had been repaired in a Trinidadian shipyard in 1988. Repairs to the engine were negligently performed so that the engine exploded, causing damage to the vessel and loss of use. The claimants made a claim against the shipyard. The underwriters relied on two defences: avoidance for breach of the duty of utmost good faith; alternatively, breach of one of the general conditions of the policy, which required the assured to keep the insurers "fully advised" in the event of any occurrence which might result in a claim. It was held that it is only appropriate to invoke the remedy of avoidance in a post contractual context in situations analogous to situations where the insurer has a right to terminate for breach. For this purpose the fraud must be material in the sense that the fraud would have an effect on underwriters' ultimate liability. The insurer will not, therefore, be able to avoid the contract of insurance with retrospective effect unless he can show that the fraud was relevant to his ultimate liability under the policy and was such as would entitle him to terminate the insurance contract.

Thus, the law relating to utmost good faith stands as follows now-

1. The common law imposes a reciprocal duty of good faith on the parties to insurance and reinsurance contracts (i) at the time the contract is made (pre-contractual duty) and (ii) following the making the contract (post-contractual duty). The nature and extent of the pre-contractual duty and the post-contractual duties are, however different.

2. At the pre-contractual stage, there is a positive obligation on the parties" to disclose all facts material to the risk and to refrain from material misrepresentation. The only remedy the common law allows for breach of the duty of good faith is avoidance of the contract of insurance or reinsurance. Damages for breach of the duty of good faith are not available.

3. There does not appear to be a general duty that the parties perform the contract of insurance or reinsurance in good faith. Thus there is no basis under English law for awarding damages against an insurer or a reinsurer for "bad faith" in relation to the handling of claims.

4. However, there does appear to be a continuing duty on the parties not to be materially fraudulent in relation to the performance of the contract. After the contract has been made, the duty of good faith includes but is not confined to (i) cases analogous to the pre-contractual context, such as variation of the risk, and (ii) a requirement that the assured refrain from making fraudulent claims.

5. In a post-contractual case, the underwriter is entitled only to avoid the contract with retrospective effect if he can show (i) that the fraudulent conduct of the assured was relevant to the underwriter's ultimate liability under the contract and (ii) was such that it would entitle him to terminate the contract for breach.

6. When a claim is made, the assured is, as a matter of principle, under an obligation to disclose all material facts to the underwriter's agents investigating the claim. However the failure to make full disclosure, unless it was materially fraudulent, does not entitle the underwriter to deny an otherwise valid claim. Once a writ is issued, the obligation of disclosure is governed by the relevant procedural rules and the consequences of a failure to disclose relevant documents are also determined by reference to those rules.

Never the less, S.20(1) of Marine Insurance Act,1963 says that the duty to disclose continues till the time the contract is concluded.

Facts which need to be disclosed and facts which need not be disclosed-

Facts required to be disclosed-

1. A fact which is earlier immaterial but becomes material later on must be disclosed if it has been expressly mentioned in the terms and conditions of the policy. Eg. Fire insurance of ones house. Earlier, vacant plot located nearby. Later on a petrol pump is constructed on such plot.

2. A fact which increases the risk must be disclosed in all circumstances. E.g. incase of theft insurance, if a person lives alone in an isolated place, the same needs to be compulsorily disclosed as it increases the risk.

3. Previous losses incurred and claims under previous policies needs to be disclosed. This is mainly in case of double insurance where it needs to be ascertained as to whether the subsequent insurance company is willing to insure and to what extent.

4. Special terms and conditions under previous policies if any.

5. Fact of existence of non-indemnity is to be disclosed. This relates to any charge or encumberance on the policy in the form of a loan security or otherwise.

6. The description of the subject matter must be stated properly. This is mainly to locate the property if it is immovable and to recognize it if it is movable.

7. Facts which suggest any special motive to take the insurance.

8. Facts which suggest the existence of any moral hazards which relate to the moral integrity of the proposer, etc.

CASES:

1. Economides v. Commercial Union Assurance Co. plc, (1997) 3 All ER 636

It was held that the duty of the assured to disclose all material facts required an assured only to disclose facts known to him. There is no obligation on the assured to make enquiries as to the factual basis of his belief.

Facts which need not be disclosed-

1. Fact lessening the risk need not be disclosed.

2. Public knowledge. E.g. facts regarding govt. policies, taxes, subsidies, etc. which are expected to be known to all.

3. Fact of law like rules, regulations, etc. which have already been made available to all by way of the notification in the official gazette.

4. Superfluous facts or such information which is not logical.

5. Facts which are inferred information.

6. Fact waived by the insurer himself.

7. Facts governed by the policy itself.

CASES:

1. LIC v. Shakunthalabai, AIR 1975 AP 68

In this case, the insured had failed to disclose that he suffered from indigestion for a few days and took chooram from an ayurvedic doctor. He died within that year due to jaundice. The insurer repudiated the claim on this account. The court did not approve of the repudiation as the insurer did not establish by clear and cogent evidence that the question was properly explained to the insured and that he was told that illness included such casual disturbances to health and medicines included tablets that could be purchased at the nearest coffee store.

2. Bhagwani Bai v. LIC of India, AIR 1984 MP 126(130)

The insurer cannot avoid or repudiate an insurance policy on the ground of non-disclosure of lapsed policies by the assured which had no bearing on the risk taken by the insurer.

Principle of utmost good faith under the Marine Insurance Act, 1963- (check book)

The Marine Insurance Act, 1963 is somewhat relaxed in application when it comes to the principle of utmost good faith. This is mainly because of the problems of access to the vessel, cargo, etc. as well as the jurisdictional problems associated with international waters. If at any point of time, the vessel or cargo is destroyed on high seas, the time when the same came to the knowledge of the parties needs to be considered rather than the general principles of insurance contract. Ss. 19-23 of the act talk about the principle of utmost good faith by using the terms disclosure and representation. S.19 lays down the general principle and says that in absence of utmost good faith, the contract may be avoided by the parties. S.20(1) says that the assured must disclose every material circumstance he knows. Thus, the knowledge of the insured is more important than the actual happening of the event. S.22(1) says that the representation made by the insured must be true, which is again dependent on the capacity of the insured to know the truth and is hence subjective. Finally, S.22 also says that whether the assured failed to disclose intentionally or innocently or inadvertently is immaterial.

Conclusion-

Thus, this principle forms an integral part of insurance law. It gives a fair chance of risk assessment to the insurer and also ensures that the assured fully understands all the terms and conditions of the contract. But, this principle is more favourable to the insurer as it is the assured who has to generally make all the disclosures. This is primarily because when this doctrine was evolved in the 18^th century, the insurance market was in its infancy and thus required protection. However, the enactment of the English Unfair Contract Terms Act, 1977 has considerably alleviated the position of the assured who is now protected against unfair contractual terms. Further, the Insurance Act lays down that an insurance policy cannot be called in question two years after it has been in force. This was done to obviate the hardships of the insured when the insurance company tried to avoid a policy, which has been in force for a long time, on the ground of misrepresentation. However, this provision is not applicable when the statement was made

fraudulently. Never the less, technological advancements have further made it possible for both parties to see to it that their interest is taken care of. But, there are several other grey areas to this doctrine as well. There is still no clear cut distinction between as to what is material or immaterial and the same is largely dependent on the whims of the insurers and the terms of the contract. It is still very easy for an insurer to repudiate the contract on the slightest point of non-disclosure by treating them as warranties, thereby putting the assured in an even more difficult position. Another problem is with regards to as to what duration does the disclosure(s) need to be made. Common law cases may somewhat seem to have settled this point but the Indian Marine Insurance Act still shows a confusion regards the same as it says that duty of disclosure shall end with the conclusion of the contract. Thus, all these problems need to be taken care of and an effective solution must be provided considering the principle of utmost good faith is one of the most fundamental principles associated with insurance law.

Important cases

1. Bank of Nova Scotia v. Hellenic Mutual War Risks Association (Bermuda) Ltd. (1989) 3 All ER 628

It was held that an assignee of the assured is not the assured as such and hence owes no duty to disclose to the insurer.

2. Drake Insurance plc. v. Provident Insurance plc. , (2003) EWHC 109 (Comm)

It was held that the remedy of avoidance of a contract is a self help remedy and could not be overturned by the court by the exercise of its equitable jurisdiction.

3. Banque Finaciere de la Cite v. Westgate Insurance Co. Ltd., (1989) 2 All ER 982