Insurance is a paid service: in return for a premium, paid at the time and in the manner set out in the insurance agreement, the insured or the beneficiary enjoys peace of mind, having transferred its risks to the insurer. In exchange, the insurer is entitled to compensation for assuming the insured's risks.
Article 954 of the Civil Code, which deals with insurance premiums and fees, provides that parties are free to choose the manner in which insurance premiums are paid. Since insurance premiums are sometimes large, agreements often allow premiums to be paid in instalments. However, where such contractual terms are used, insurers may face a situation in which the insured is unwilling to pay the premium stipulated by the contract. Such problems usually occur towards the end of a contract.
When an insured pays the first part of the premium and then fails to pay further instalments, a paradox arises. If an insured event occurs, the insured claims under the contract; if the event does not occur, the insured simply chooses to ignore the debt to the insurer and to keep the outstanding amount of the premium. The contract has ended and nothing has happened - why should the insured pay?
Statistics suggest that insureds as a whole underpay between 10% and 20% of the total amount of insurance premiums. However, insurers rarely seek to enforce such contracts in court. They may fear losing a client, particularly where large-scale risks are insured, or other pragmatic considerations may come into play - for example, litigation may not be a cost-effective solution for smaller debts. Insurers are traditionally regarded as holding the stronger position in an insurance relationship; however, they need protection from bad-faith conduct by insureds.
Existing legislation and recent court practice reveal inconsistencies in determining the consequences when an insured defaults on payment of part of its insurance premium. The problem has given rise to many court disputes. The fault arguably lies in the applicable legislation, which should give parties less freedom and instead prescribe specific consequences in order to eliminate uncertainty. For example, it could be stipulated that a default on a premium instalment constitutes unilateral refusal to perform under the contract. This would avoid situations in which a premium is not paid, but the insured nonetheless claims for compensation.
Article 954(3) of the code allows parties to negotiate and agree on the effects of default on an instalment. It is not uncommon for an insurance contract to provide for the termination of the contract in the event of default; penalty provisions are also widely used. Such a contract may also provide that the period during which payment is delayed is excluded from coverage.
The courts have taken various approaches to clauses which provide that a party's default on a premium instalment terminates an insurance contract. The Supreme Arbitrazh Court has stated(1) that where parties have agreed that the insurance premium is to be paid in instalments, and where the insurance contract purports to terminate automatically once the insured defaults on a due and payable instalment, the insurer remains bound to fulfil its own obligations without notifying the insured of its intention to discontinue performance of the contract.
In the case that led to the Supreme Arbitrazh Court's statement, the policy provided that in the event of late payment of an insurance premium, the insurer was released from its obligation to pay insurance compensation and the contract was deemed to be terminated. The court took the side of the insured and pointed to the fact that the insurer had not exercised its right of unilateral refusal to perform the contract; nor had it indicated to the insured that it intended to discontinue performance in such circumstances.
However, the court has previously taken a different approach(2) and has upheld a lower court decision that an insurer was not liable to pay insurance compensation. In this case the court accepted that an insurance contract may terminate automatically if the insured fails to pay a premium instalment on time.
The Federal Arbitrazh Court of the Central District appears to share this view. It has previously indicated(3) that a unilateral refusal to perform a contract, where such refusal is permitted by law or by the terms of the contract, is an event that may cause the contract to be terminated or varied. Therefore, an insurer need not take additional steps to terminate if it has been agreed that defaulting on a premium payment will amount to termination of the contract.
Thus, the courts are moving towards recognising the possibility of automatic termination of insurance contracts - without additional steps by the insurer - where the contract contains a provision to this effect and does not require additional steps to give effect to such termination.
Such judicial practice improves the transparency of insurance business. It also reinforces the liabilities and obligations of all parties - agreements must be kept and the insured must be prepared to pay for the insurer's service.
Most recently, a new case has arisen which will be interesting to follow as it progresses through the courts. Case А41-15438/10 involves a term frequently found in many insurance contracts: a clause for the 'suspension of insurance coverage' for the period of delay in payment of insurance contributions. In this case the appellate court instructed a lower court to reconsider the legal effect of suspending insurance coverage for the period of default on premium payments. The court was asked to determine whether the suspension operates to extinguish the insurer's obligation to pay compensation in respect of an insured event that occurred while the insured was in default, or whether the obligation to pay arises, but performance is not due until the overdue premium payment is made. The next hearing, at which a decision may be handed down, has been scheduled for June 29 2011 before the Moscow Regional Arbitrazh Court.
For further information on this topic please contact Polina Kondratyuk at Clyde & Co (CIS) LLP by telephone (+7 495 728 99 55), fax (+7 495 926 49 40) or email ([email protected]).
(1) Section 16 of Information Letter 75 of the Supreme Arbitrazh Court.
(2) November 20 2008, case А43-28038/2007.