Over the course of two articles, we consider English law's response to fraudulent representations made by an insured in the course of insurers' investigations (the subject of this article) and in statements made in litigation proceedings which induce settlement (the subject of the next article).
Fraud can come in many guises: from deliberately deceiving underwriters on the nature of the risk to be insured, to exaggerating the circumstances or extent of any loss. Insurers often have to rely upon information provided by insureds when assessing claims which could, unbeknown to insurers, include misrepresentations by the insured intended to obtain a higher settlement amount or achieve payment more quickly. In this article we consider English law's draconian approach to fraudulent statements and how insurers could better identify potentially untrue statements.
It is well understood that the insured owes a duty of utmost good faith, including in respect of any claims presentation and co-operation. That duty includes not making fraudulent claims or using fraudulent devices. The duty applies throughout the parties' relationship.
2. Fraudulent Devices
A fraudulent claim is one in which an insured knowingly seeks a benefit to which it is not entitled. Fraudulent devices were historically distinguishable from fraudulent claims and have been defined by the English Court of Appeal as “[t]he making of statements which are known by the insured to be untrue or which are made recklessly, not caring whether they are true or false, in support of a claim honestly believed by him to be good both as to liability and amount”. Most commercial policies will include an express term providing that in the event of a fraudulent claim the insured forfeits all benefits under the policy. Absent an express term, the English common law imposes such a requirement pursuant to the duty of good faith.
Where fraud is established, the claim fails in its entirety (including that portion which is genuine and indemnifiable) and the policy may be terminated, even in circumstances where an insured could have successfully maintained the claim without the use of fraud. This principle seeks to ensure that an insured will not gain from the use of fraud and will lose everything if fraud is employed. The principle is draconian by design to deter the deception of insurers who have no or little knowledge of the incident giving rise to the claim.
3. Versloot Dredging: The High Court
In the English High Court case of Versloot Dredging the judge held at first instance that the fraudulent claims rule applies as much to: (i) fraudulent maintenance of an initially honest claim; and (ii) a claim which the insured knows from the outset to be exaggerated. No distinction is to be drawn between fraudulent claims and devices. The case concerned a claim under a hull policy covering a vessel whose engine room flooded. The insured sued for an indemnity which insurers declined to pay. Insurers defended on three grounds: (i) the loss was caused by an uninsured peril; (ii) the loss was caused by the unseaworthiness of the vessel with the knowledge and privity of the Insured; and (iii) the claim was supported by a fraudulent statement.
During the course of the claims process, insurers questioned the insured's management about the rate of ingress of water into the engine room. Insurers could not understand from the facts how such a large volume of water could have entered the engine room without being discovered by the crew until it was too late to prevent the resulting loss. On two occasions, insurers requested the insured's management to confirm why such ingress had apparently either gone unnoticed for so long or how it had occurred as quickly as it did. The insured's General Manager sought to blame crew negligence for the loss (which was an insured peril) and gave two separate statements to insurers. The relevant one for the purpose of the Judge's findings confirmed that “[a]fter further investigation…the first engine room alarm went off at noon…not investigated… [assumed rolling has set off the alarm]. Time of leakage is around 13.00hrs on 28 January.” At trial, the insured did not maintain that the alarm had sounded at noon and there was no evidence it had sounded at any time on the date of loss before about 9pm.
The Judge held that the explanation provided was a matter of pure speculation rather than based on anything the crew had told the General Manager. On a scale of culpability, the Judge found that this was "at the low end" and that it was a reckless untruth, believed by the General Manager to be a plausible explanation, not a carefully planned deceit. It was said on one occasion (in a statement to insurers) and not pursued at trial. The General Manager had made no attempt to investigate or speak with the crew before answering the insurers' query. The response was given as it was assumed that it would lead to a speedy resolution of the claim and prompt payment of settlement monies, much needed to secure the release of the vessel from the shipyard.
The trial Judge applied the non-binding decision of Mance LJ in The Aegeon when considering the effect of the General Manager's statement and held that the statement: (i) was directly related to the claim; (ii) was intended to promote the insured's prospects of success; and (iii) if believed, would have yielded a not insignificant improvement of those prospects, and in that event found that the statement was a fraudulent device which the insured intended to rely upon to promote its claim.
The trial judge: (i) dismissed insurers' first two defences; (ii) held that crew negligence was the cause of loss (an insured peril); and (iii) held that a fraudulent statement was made to support the claim. The claim was accordingly dismissed which otherwise, but for the fraudulent statement, would have succeeded.
4. Versloot Dredging: Court of Appeal
The Court of Appeal would not interfere with the High Court Judge's findings of fact, but considered whether the non-binding decision in The Aegeon should be applied in respect of fraudulent devices/statements used in support of claims. The Court held that it should apply that decision and confirmed the following test in respect of ascertaining whether a device is fraudulent:
- The device must be directly related to the claim, as opposed to some dispute with a third party [Objective test];
- The device must have been intended by the Insured to promote its prospects of success[Subjective test]; and
- It must not be irrelevant, such that, if believed, it would tend to yield a significant improvement in the insured’s prospects of success prior to any final determination of the parties’ rights [Objective test].
The Court confirmed that a fraudulent device will result in the forfeiture of the claim and no return of premium. The Court further noted that the obiter decision in The Aegeon had been also been applied in New Zealand and India, as well as England.
5. Law Reform
The UK Law Commissions' July 2014 Report, which has been implemented within England's Insurance Act 2015 (not yet in force), observes in respect of fraudulent devices, “[t]he Aegeon has led to a sudden surge in insurers' lawyers pleading fraudulent means and devices as a way of deterring the insured’s claim", but the Commission has not militated against the common law principles in respect of fraudulent devices. Much in the Report supports the application of the rule to devices as well as claims. Section 12 of the Insurance Act 2015, confirms that if the insured makes a fraudulent claim, insurers: (i) are not liable to pay the claim; (ii) may recover from the insured any sums paid in respect of the claim; (iii) may treat the policy as having been terminated with effect from the time of the fraudulent act (but not affecting the rights and obligations of the parties prior to the fraudulent act); and (iv) if the policy is terminated, are not obliged to return any of the premium paid. However, there is no definition of“fraudulent claim” in the Act and the Law Commission had taken the view in its Report that that is a matter for the Courts to determine. That said, the notes to the initial draft Bill indicated that one of the acts which would make a claim fraudulent would be the used of fraudulent means or devices to support a genuine claim.
Insurers should be alert to statements from those within the insured's organisation who have no direct knowledge of the circumstances or facts giving rise to the incident and subsequent loss. Where necessary, confirmation from the insured should be sought that appropriate investigations have been undertaken and that the relevant personnel with the requisite knowledge have been interviewed. Loss adjusters and brokers should be aware of the insured's duties and the draconian legal effect of untrue statements. Insurers may wish to carefully consider any factual statements made which are accompanied with pressure to make prompt payment and, where necessary, inform the insured tactfully of its duties when responding to insurers' queries.