In an earthquake related judgment issued in late December 20161, the High Court (Court) found a mutual duty of good faith applied to parties to an insurance contract, including during the claims handling process. A breach of that duty may result in an award of damages.
This is a new development in insurance law in New Zealand, and it will have implications in the way insurers deal with their customers. The judgment also considers the effect of the following words used in a basis of settlement clause: 'construction methods commonly used at the time of loss or damage'.
The insureds' residential house on the Port Hills in Christchurch was damaged in the Canterbury earthquake sequence. The main issue was whether, in accordance with the insurer's obligations under the policy, the house could be repaired or whether it had to be replaced. The insureds also alleged that the insurer had breached its duty of good faith to the insureds and sought general and exemplary damages against the insurer.
Standard of repair – 'construction methods commonly used'
When considering whether the insurer’s proposed repair strategy met this policy requirement, the Court stated that:
… while it is the [insurer's] election to choose to repair a damaged house if satisfied it is not a rebuild, the policy obligation on the [insurer] is to ensure the repair strategy adopted and the construction methods involved are ones commonly used at the time of the earthquake.
The Court noted this obligation serves the dual purpose of saving money for the insurer (in that expensive historic materials or construction methods would not be required) and minimising the risk or uncertainties for the insured in adopting a novel or revolutionary construction method never or rarely tried or tested before.
The Court was not satisfied that the insurer's proposed winching strategy for the house could be considered a construction method commonly used at the time of the earthquakes or even soon after. No evidence was provided to the Court that this method had been satisfactorily undertaken at other properties in New Zealand or overseas.
As this was the only repair method proposed by the insurer, the Court concluded that the damage to the house was not repairable and awarded $1,620,887 for the cost of the replacing the house, based on the insurer's figures.
General and exemplary damages
The Court confirmed that exemplary damages for a breach of contract are not permitted in New Zealand. In any event, it found there was no evidence that the insurer's behaviour approached the standard required for an award of exemplary damages in tort or otherwise.
In relation to general damages, the Court found they could be awarded in a case such as this:
- where the loss incurred is a foreseeable loss as a result of the insurer’s breach of contract; or
- where the loss is incurred as a result of a breach of a term of good faith between the parties.
In this case, the insurer did not unjustifiably decline the insureds' claim. The alleged breach occurred when the insurer chose a repair strategy which the insureds considered to be contrary to the terms of the policy. The Court found that the non-pecuniary losses claimed by the insureds did not fairly arise from that breach, or both parties would not have contemplated them during the formation of the insurance contract.
Duty of good faith
However, the Court noted that it has never been settled in New Zealand law whether an insurer owes a duty of utmost good faith to insureds beyond the initial duty of disclosure, ie extending to the handling of the claim. After a review of recent cases which had left this point open, the Court found that:
a duty of good faith on the part of the insurer is implied in every insurance contract.
The full scope and limits of the duty were 'left for another day', but as a bare minimum the Court stated that the duty requires the insurer to:
(a) disclose all material information that the insurer knows or ought to have known, including, but not limited to, the initial formation of the contract and during and after the lodgement of a claim;
(b) act reasonably, fairly and transparently, including, but not limited to, the initial formation of the contract and during and after the lodgement of a claim; and
(c) process the claim in a reasonable time.
What is reasonable will depend on all the circumstances of the claim. The Court also pointed out that if the insurer shows that reasonable grounds exist for disputing the claim (whether as to the amount payable or whether anything is payable), an insurer does not breach the implied term merely by failing to pay the claim while the dispute is continuing.
In this case, the insurer did not initially disclose to the insured an early and brief report from a contractor that did not support the insurer's position that the house was capable of repair. The Court found that the failure to provide the report was a breach of the insurer's obligation of good faith. The Court awarded nominal damages of $5,000 to the insureds for the failure to disclose this document to the insureds in a timely manner. However, the Court refused to award any general damages based on the insureds' argument that settlement of the claim had been unreasonably delayed.
This is the first decision of a New Zealand court implying a mutual duty of good faith by both parties to an insurance contract during the term of the contract.
As this decision demonstrates, one of the practical implications of this is that insurers must now disclose to insureds all reports commissioned by the insurer about the insured damage, even if they are adverse to the insurer's view of the claim. This obligation arises despite no proceedings being on foot requiring discovery of documents.
This change in the law will require a change in the way some insurers deal with reports they commission from contractors and experts. The insured is entitled to complete transparency now.
Although the court did not address this issue, the obligation does not, presumably, cut across the law relating to litigation privilege. We may have to wait for a future case before this is clarified.