Last week, the Court of Appeal authoritatively confirmed that an insured who seeks to employ a fraudulent device against its own insurers will forfeit the whole of its claim. The decision of Versloot Dredging BV -v- HDI Gerling Industrie Versicherung AG clarifies the position for insurers in respect of first party fraud and emphasises that the courts are cracking down on dishonesty. Richard Allingham and Stratos Gatzouris take a look at the reasoning behind the decision and how this will affect marine and non-marine insurers.
Background - fraudulent claims and fraudulent devices.
It is established common law in first party claims that if an insured makes a fraudulently inflated claim under its policy, it will forfeit any lesser claim which it could have properly made. This rule exists to deter insureds from deceiving their insurers who will inevitably know less about the circumstances surrounding the claim than the insured. Unlike third party fraud, the forfeiture rule for first party fraud is based on the duty of utmost good faith upon which every insurance contract is based.
The question in this case was this: does the rule about fraudulent claims apply to fraudulent means or devices? In other words, if an insured uses a fraudulent device to support a claim, should they forfeit the whole claim?
A fraudulent device was defined in Agapitos -v- Agnew (“THE AEGEON”) as being used if ‘the insured believes that he has suffered the loss claimed but seeks to improve or embellish the fact surrounding the claim by some lie’. It can be a false signature, an amended invoice or false information provided in support of an otherwise genuine claim. In “THE AEGEON”,the court held obiter that the rule on fraudulent claims extended to fraudulent devices. As this was obiter, it was persuasive but not binding and courts have adopted inconsistent approaches.
In Versloot Dredging BV -v- HDI Gerling Industrie Versicherung AG the Court of Appeal has clarified the position with a unanimous ruling.
The claimant’s vessel, the “DC MERWESTONE”, suffered a flood causing irreparable damage to the engine - in waters close to Lithuania, water was left in the emergency pump and the sea valve was not closed. Due to extremely low temperatures, the water froze, expanded and cracked the pump resulting in a direct opening to sea water. As the vessel reached warmer waters, the ice melted and sea water flooded the engine.
During the investigation, the insurers sought an explanation for the flood and the apparent failure to manage it. In a letter to the insurers, the owners made a representation that appeared to lay the blame for failing to manage the flood with the crew, by stating that the bilge alarm had gone off on the day of the incident but that the crew had chosen not to investigate, attributing it to the rolling of the vessel. It transpired that this representation had been made without investigation and while the owner did not know that it was false, he consciously chose not to investigate because he did not want to know that it was false. The owner later claimed that the representation was a hypothesis and was not intended to be construed as fact. This was not accepted. At first instance, the court held that it was a reckless untruth made with the intention of improving the prospect of payment of the claim that amounted to a fraudulent device and, applying the decision in “THE AEGEON” ruled that the claim was forfeit.
The owners appealed on various grounds of fact and law. The appeal in law was twofold. Firstly, the owners submitted that the rules about fraudulent claims should not apply to fraudulent means or devices. Secondly, they submitted that if the rule were to apply to fraudulent devices, then it would be in breach of the right to protection of property as set out in Article 1 of the First Protocol to the European Convention on Human Rights.
Extension of the forfeiture rule
The Court of Appeal dismissed the owner’s argument that the rules about fraudulent claims should not apply to fraudulent devices. In the leading judgment, Clarke LJ gave six reasons why the rule should extend to fraudulent devices:
- While the decision in “THE AEGEON” is not binding, it is authoritative.
- A fraudulent device is a sub-species of a fraudulent claim and applying the rule to fraudulent devices adopts a coherent approach, based upon the special relationship between insurer and insured: ‘The fraudulent insured must not be allowed to think if the fraud is successful, then I will gain; if it is unsuccessful, then I will lose nothing.’
- It is a matter of public policy. While arguably harsh, the consequence of forfeiture will only apply to those who are dishonest.
- The court also relied on the numerous consultation papers that have been published as part of the recent spate of insurance law reform; which seemingly take for granted that the rule of forfeiture for fraudulent claims already applies equally to fraudulent devices.
- There is antecedent authority supporting the application of the rule to fraudulent devices
- “THE AEGEON” has been cited without disapproval in a number of subsequent cases.
The court saw no need to consider the issue of proportionality on the basis that it is the drastic effect of the forfeiture rule that gives it its deterrent effect.
Right to protection of property
The owners also argued that if the forfeiture rule were to apply to fraudulent devices, then it would be in breach of the right to protection of property as set out in Article 1 of the First Protocol to the European Convention on Human Rights (ECHR). While the court agreed that forfeiture of an insurance claim might constitute an interference with property; the forfeiture rule was justifiable on the basis that it acted as a deterrent against insurance fraud and therefore achieved a proportionate and legitimate public policy aim.
Dismissing each of the factual and legal arguments on appeal, the court found that the extension of the forfeiture rule to fraudulent devices was a proportionate means of securing the aim of deterring fraud in relation to insurance claims. As Clarke LJ said at paragraph 155: ‘The rule is only applicable in the case of fraud, from which no insured should have any difficulty in abstaining. The careless or forgetful insured is not affected, nor is the insured who tells some irrelevant lie or whose lie is not told in order to induce payment.’ Clarke LJ specifically incorporated the persuasive decision set out in “THE AEGEON” as binding law in this case.
Following on from this decision, an insured will now forfeit the entirety of its claim if it employs a fraudulent device that satisfies the following test:
- the device must be directly relevant to the claim;
- the device must have been intended by the assured to promote his prospect of success; and
- the device must not be irrelevant but such that, if believed, it would have tended to yield an improvement in the insured’s prospects of success prior to any final determination of the parties rights.
What does this mean for insurers?
It remains to be seen whether this decision will be appealed to the Supreme Court. However, this is a welcome decision for insurers who will now benefit from a clearer position. If an insured employs a fraudulent device in a claim it will forfeit the whole of the claim. This sends out a clear message that fraud - under any guise and to any extent - will not be tolerated.