In Sharon's Bakery (Europe) Ltd v (1) AXA Insurance UK Plc (2) Aviva Insurance Ltd  EWHC 210 (Comm), the insured brought a claim against its insurers seeking an indemnity for damage to bakery equipment caused by a fire at the insured's premises. Mr Justice Blair held that insurers were entitled to avoid the policy because the insured had failed to disclose to insurers that it had produced and used a false document in the course of a loan application, and this constituted a "moral hazard". The Judge also found that, by submitting a false document in support of its claim, the insured had used "fraudulent means or devices", and so, by the terms of the Policy forfeited all benefit under it.
In 2007, Mr Nassim and Mr Caplin agreed to found a new company, which was to be called Sharon's Bakery (Europe) Ltd ("Europe"). It was agreed that Europe would operate from Mr Caplin's premises and Mr Nassim would transfer bakery equipment from his former bakery company, Sharon's Bakery (Wholesale & Retail) Ltd ("Wholesale"), to Europe.
At the end of 2007 or beginning of 2008, Mr Caplin approached Lombard Finance ("Lombard"), for secured lease financing for Europe to fund Europe's acquisition of the bakery equipment.
In support of Europe's loan application, Mr Caplin faxed two documents to Lombard on 3 March 2008:
- An invoice dated 3 February 2008 from Wholesale to Europe showing a list of bakery equipment with serial numbers and amounts; and
- A document dated 15 November 2007 in the form of an invoice purportedly issued by a company called Bakequip to Wholesale and containing a list of equipment identical to the list in the 3 February invoice (the "November Document").
The factual dispute between the parties centred on the November Document.
It was common ground that there was no sale of equipment from Bakequip to Wholesale. Europe conceded that the November Document was in fact produced by Mr Levy of Bakequip in February 2008 rather than November 2007. However, it argued that the November Document was not an invoice, but a valuation of the equipment, and had been produced at Lombard's request. Lombard denied that it had requested a valuation of the equipment and said that it had requested evidence that Europe had good title in the equipment. The November Document was an invoice purporting to be evidence of the sale of the equipment from Bakequip to Wholesale.
According to the claimant, on 5 March 2008, Lombard requested that the November "valuation" provided to Wholesale by Bakequip should be re-addressed to Europe. Mr Caplin said that, on 11 March 2008, a revised version of the November Document showing the customer as Europe (rather than Wholesale) and dated 3 February 2008 (the "February Document") was provided to Lombard. This version of events was denied by Lombard.
Europe proceeded to transfer the bakery equipment to Lombard who, in turn, advanced the loan monies to Europe.
In the meantime Europe took out insurance with AXA and Aviva against, inter alia, fire risks.
On 8 June 2008, a fire at Europe's premises caused damage to Europe's bakery equipment.
The February Document was provided to adjusters as evidence of the transfer of ownership of the bakery equipment to Europe. However, Mr Levy then intervened, pointing out that there were two versions of the Bakequip invoices, both of which were false: the November Document addressed to Wholesale and the February Document addressed to Europe. Insurers avoided the policy.
Europe commenced proceedings. Insurers defended the claim on two grounds:
- Material non-disclosure of a "moral hazard" – Europe was obliged, and failed, to disclose to insurers (a) the fact that it had produced the false invoice (the November Document) in support its loan application; and (b) the dishonest conduct of the directors in submitting a false document to Lombard; and
- Fraudulent means or devices - Europe had submitted to insurers a document (the February Document) in support of its claim which it knew to be false. It had used "fraudulent means or devices" to support its claim and forfeited all benefit under the Policy.
Europe, on the other hand, argued that the November Document and February Document were valuations, rather than invoices evidencing title, and that its directors had acted honestly throughout.
Blair J found that Lombard had not in fact requested a valuation, nor had Lombard been told by Europe that the November Document constituted a valuation. The Judge was satisfied that, given the nature of the transaction, Lombard had requested evidence of title, and this is what Europe purported to provide in the form of invoices. Blair J noted that Europe accepted that the November Document was false, as Bakequip had never supplied equipment to Wholesale. Further, he found that Europe, through its directors, knew that the invoice was false.
Blair J noted that the claimant accepted that material facts, for the purposes of the duty of utmost good faith, included facts affecting the "moral hazard".
The Judge considered the case of Insurance Corporation of the Channel Islands v The Royal Hotel Ltd  Lloyd's Rep IR 151. The insured in that case had created false invoices which were intended to be (but were not in fact) submitted to the insured's bankers. Mr Justice Mance (as he then was) found that the creation of false invoices was a matter which any prudent underwriter would have taken into account when deciding to provide insurance. Prior acts of dishonesty by the insured were, he held, capable of being material even if they went undetected. It was a question of fact and degree whether a prudent underwriter would take any particular act of dishonesty into account.
Blair J then turned to the phrase "moral hazard", which he said was "used to describe circumstances, invariably involving dishonesty on the part of the assured, which give rise to a concern that there will be dishonesty in the reporting and presentation of claims".
Royal Hotel was authority for the proposition that dishonesty in relation to the insured's bankers was clearly material to be known to a prudent underwriter. The test of materiality (i.e. what would influence the judgment of the prudent underwriter) was an objective test. There was room for a test of proportionality, having regard to the nature of the risk and moral hazard under consideration.
In Europe's case, a false invoice had been produced which was used for the dishonest purpose of inducing Lombard to provide a loan. The mere creation of the false invoice by Mr Levy would not, of itself, have been sufficient. But if the insured asked Mr Levy to produce the false invoice, this constituted a moral hazard which should be disclosed to insurers (even if, as in Royal Hotel, the invoice was not in fact used).
Even if (contrary to Blair J's findings) Mr Levy had been asked by Europe to produce a valuation and instead produced a false invoice, the fact that it was false would have been apparent to Europe's directors. By then sending the invoice to Lombard, Europe would have adopted and perpetrated the lie the document contained. Hence, this circumstance was also a moral hazard which should be disclosed to insurers.
As for inducement, Blair J accepted the evidence of the junior underwriter involved that, had he known of any dishonesty in Europe's dealings with Lombard, he would not have offered any insurance to Europe.
Fraudulent means or devices
The Policy contained the following provision which it was common ground effectively replicated the common law on forfeiture of insurance claims (although arguably the clause goes rather further than the common law in that any benefit under the Policy is forfeited as opposed simply to the claim which is the occasion for the fraud):
"If any claim upon this Policy shall be in any respect fraudulent or if fraudulent means or devices be used by or on behalf of the insured to obtain any benefit under the Policy…all benefit under the Policy shall be forfeited."
Referring to the decision of Lord Justice Mance (as he then was) in Agapitos v Agnew  EWCA Civ 247, Blair J held that, in order to succeed, the insurers must show:
- the use by the insured of some lie to seek to improve or embellish the facts surrounding the claim; and
- that lie would, if believed, have tended objectively to yield a not insignificant improvement in the insured's prospects of obtaining a settlement.
Blair J noted that, after the fire, Europe's insurers expressly requested invoices confirming the transfer of the equipment to Europe, and in response Europe had provided an invoice showing the sale of equipment from Bakequip to Europe (the February Document). The representation in the invoice that there had been a supply of equipment from Bakequip to Europe was a lie, and Europe adopted the lie by providing the invoice to insurers in response to their request. They therefore embellished the facts surrounding the claim.
Blair J also found that, if believed, the lie would have tended objectively to yield a not insignificant improvement in the prospects of the claim being accepted. Europe had therefore used a "fraudulent means or device" and had forfeited any benefit under the Policy.
Sharon's Bakery demonstrates the strict approach adopted by courts when faced with dishonest behaviour on the part of insureds. Blair J emphasised that this was not a case in which the insured was dishonestly advancing a claim to which it knew it was not entitled: the Judge accepted that the claim was, on its face, perfectly legitimate and accepted the insured's case on quantum of loss. Nevertheless, insurers were entitled to avoid what was otherwise a valid claim.
That insureds may be obliged to disclose dishonest conduct to their insurers, in circumstances where they have neither been accused nor convicted of an offence, might be considered somewhat unrealistic. Nevertheless, the case law is clear. Indeed, it will be recalled that "moral hazard" does not merely extend to actual dishonesty, but also to allegations of dishonesty against the insured which the insured knows to be false (North Star Shipping Ltd & Ors v Sphere Drake Insurance plc & Ors  EWCA Civ 378).
The far-reaching scope of a "moral hazard" as a matter for disclosure is demonstrated in this case by the fact that Blair J would have reached the same conclusion even if the false invoices had not in fact been submitted to Lombard at the time of the claim.
Further, following Sharon's Bakery, it is also evident that a moral hazard for an insured can arise even where the false document is created by a third party independently, and not at the request of the insured. If it is apparent to the insured that the document created by the third party is false, and the insured nevertheless uses that false document (e.g. in support of a loan application), they may be deemed to have "adopted and perpetrated the lie the document contained". Failure to disclose this fact to insurers may allow insurers to avoid the policy. And if the document is used in support of the insured's claim, this may constitute a "fraudulent means or device".