Importance of insured’s duty of disclosure

Summary

In Involnert Management Inc v Aprilgrange Ltd & Ors (Comm), the Commercial Court in London has recently upheld an underwriter’s avoidance defence with respect to a claim  on an insurance policy covering a superyacht (the Galatea). The court found that, before taking out the insurance policy, the insured’s representatives failed to disclose to the underwriter that: (i) they had obtained a market valuation for the Galatea suggesting a value approaching half of the insured sum and (ii) the yacht was being marketed for sale for an asking price nearer to that of the market valuation than the insured sum. These two findings were held to be material non- disclosures by or on behalf of the insured, entitling the underwriter to avoid the policy and defeat the insured’s claim. While the legal proceedings took place in England and were subject to English law, had the case taken place in Hong Kong the result would have been much the same, given the law relating to material non-disclosure is heavily influenced by English case law that has been adopted in Hong Kong and that section 18 (Disclosure by assured) of the Marine Insurance Ordinance (Cap. 329) is based on section 18 of the Marine Insurance Act 1906.

The Galatea

Facts – summary

The claimant BVI company (the insured) purchased the Galatea as a new yacht in  May 2007 for €13m (the original purchase price). She was what could be described as a superyacht. The insurance policy in question was taken out in May 2011, pursuant to which the Galatea was insured against all risks for a year for an aggregate value representing the original purchase price; made up of 75% (€9.75m) for Hull & Machinery (H&M) cover and 25% for Increased Value (€3.25m). The policy incorporated the American Yacht Form R12 (the R12 Clauses) for the H&M cover under section A and the American Institute Increased Value and Excess Liabilities Clauses (the IV Clauses) under section B.

The insurance was arranged through a Greek producing broker and an English placing broker (which placed the insurance in the London market).

In November 2009, the insured had obtained a market valuation report for the Galatea. This valued her at approximately €7-8m. Further, during 2011 the Galatea had been marketed for sale on behalf of the insured with an asking price of €8m.

In December 2011, the Galatea caught fire at her mooring in Athens and was damaged beyond repair. The insured’s lawyers served a Notice of Abandonment (NOA) and claimed for a constructive total loss in July 2012.

The insured claimed the original purchase price from the underwriters under the policy. The underwriters denied liability to pay the claim; principally, on the basis that the Galatea had been over-valued and that this was known to the insured and its manager at the time of taking out the policy in May 2011. The insured later joined the producing broker and the placing broker to the proceedings, claiming against them in contract and negligence and in negligence only, respectively.

Issues

A number of issues arose for determination by the court.

First, was the underwriter entitled to avoid the policy for material non-disclosure on account of the insured’s failure to disclose the market valuation and the fact that the Galatea was being marketed for sale by the insured’s manager for a sum that was substantially less than the insured sum?

Second, was the underwriter entitled to avoid the policy because of a representation on behalf of the insured in the proposal form that the market value of the Galatea was the original purchase price?

Third, was the insured’s claim contractually time-barred on the basis that the insured’s representatives had failed to make a sworn proof of loss within ninety days of the casualty (as required by the R12 Clauses)?

Fourth, in the event that the underwriter’s avoidance and limitation defences failed, had the insured failed to give NOA with reasonable diligence, such that the insured could only at most recover a partial loss under the  H&M part of the policy and, therefore, this precluded a claim under the Increased Value part of the policy?

Decision

The court held that the existence of the market valuation and the fact that the Galatea was being marketed for sale with an asking price of €8m were material facts that a prudent underwriter would want to take into account in assessing the risks of insuring the Galatea for the first time.

The court also held that the underwriter had established that they had been induced to enter into the policy on the terms agreed as a result of these non-disclosures. Had the insured informed the underwriter of the material circumstances not disclosed (the market valuation and the fact that the Galatea was marketed for sale for a lot less), the court was of theview that the underwriter would have inquired as to the discrepancy between the market value and the insured value and would probably have only agreed to insure the Galatea for €8m.

As such, the underwriter’s avoidance defence was a complete defence to the insured’s claim.

The second and alternative limb of the underwriter’s defence (the misrepresentation defence) failed, but this was not fatal to the underwriter’s denial of liability in light of the court’s decision on material non-disclosure. In short, the court accepted that the proposal form for the insurance (completed by the insured’s representative) did contain a misrepresentation that the market value of the Galatea was the original purchase price; however, this had not induced the underwriter to enter into the insurance on the terms that it did as it would probably have done so even if the proposal form had not contained any such misrepresentation.

As for the defence of contractual time bar (based on the R12 Clauses), the court held that this was a defence to a claim under the H&M part of the policy (Section A – €9.75m) but not to a claim under the Increased Value part of the policy (Section B - in respect of which the court held that the R12 Clauses did not apply). Therefore, the H&M claim was time-barred but not the Increased Value claim.

The court also held that there was no good reason to have delayed in giving NOA and, therefore, the insured’s failure to give a valid NOA prevented it from making a claim under the H&M part of the policy, although not under the Increased Value part (for which notice of abandonment was not necessary).

As for the brokers’ liability, the placing broker was found to owe no duty of care to the insured and had not breached any duty of care to the producing broker. The court held that the producing broker did owe a duty of care to the insured in contract (to act with reasonable skill and care) and in tort (for example, when assisting with the completion of the proposal form on behalf of the  insured). The producing broker was held to  be in breach of these duties in failing to take reasonable care to ensure that the proposal form recorded the yacht manager’s opinion  of the Galatea’s market value; for example, the court considered that the producing broker’s representative should have confirmed with the yacht manager’s representative what the Galatea’s market value was.

Interestingly, the court concluded that the error on the part of the producing broker caused the insured to enter into a voidable insurance policy for €13m instead of a valid policy for €8m. As a result, the producing broker was held liable for 25% of the total  hull cover that the insured would probably have recovered under the Increased Value part of the policy had a valid policy for €8m been in place (namely, €2m); as noted above, the court determined that this part of the insured’s claim was not contractually time- barred as between the underwriter and the insured.

Comment

It should be stressed that the insured’s non- disclosure was not found to be deliberate or reckless; rather, the court considered that it was inadvertent. The non-disclosure was not the actual over-valuation per se; although it should be noted that the over-valuation did approach twice the Galatea’s market value. Rather, the non-disclosure related to material circumstances known to the insured’s representatives that would have enabled the underwriter, considering taking on a high value risk for the first time, to value the Galatea at a more accurate figure.

The case also illustrates that the measure of indemnity for insurance of superyachts is  no different to the indemnity principles that underlie insurance generally. The purpose of insurance is to insure for loss; it is not to put the insured in an advantageous position in the event of loss or damage. For obvious reasons, a prudent underwriter would not want a situation in which the insured is financially better off if a loss occurred.

In cases of constructive total loss, the insured loss is usually limited to the amount for  which the vessel could have been sold or an equivalent one purchased. In the case of commercial vessels, insurance can also cover the lost capacity of a vessel to earn income. However, as the court noted with respect to the Galatea, “Owning a large yacht is usually an expensive luxury rather than an enterprise carried on for profit” and is generally for recreation and pleasure (rather than an asset employed in a business)1.

Interestingly, in this case, the judge observed that an underwriter being asked to insure a superyacht for the original purchase price, four years after it was purchased as new, would reasonably assume that it was being insured for more than the amount which the owner would be likely to obtain from selling the yacht. However, this was not relevant to the materiality of the non-disclosure.

The judge also noted that, once the Insurance Act 2015 in the United Kingdom comes into effect in August 2016, in the absence of a fraudulent or reckless non-disclosure by the insured, the court will be required to consider what the underwriter would have done in the circumstances if a “fair presentation” of the risk had been given by the insured. If the court considers that the underwriter would have issued the insurance policy on different terms, then under the Insurance Act 2015 an English court will be able to rewrite the policy  on the basis of those terms (and allow for “proportionate remedies”). In this case, the judge found that had the insured informed the underwriter of the valuation report and that the Galatea was being marketed for sale for €8m, the underwriter would have agreed an insurance policy with cover of €8m2. However, under the current UK Marine Insurance Act, the insured’s non-disclosure as regards the Galatea provided the underwriter with a complete defence to the insured’s claim3. The same result would be expected under Hong Kong law, which will obviously not be affected by the changes to English law made by the Insurance Act 2015.