By a judgment handed down on 26 October 2010 in Sugar Hut Group Ltd & Ors v Great Lakes Reinsurance (UK) Plc & Ors [2010] EWHC 2636 (Comm), Mr Justice Burton in the Commercial Court held that insurers were entitled to avoid, for a material non-disclosure of a corporate re-organisation, a policy which could otherwise have covered losses arising from a fire at the premises of the insureds. The Court also found that, had the insurers not been entitled to avoid liability for non-disclosure, they would in any event have been discharged from liability as a result of the insureds' breaches of warranty.

Background

Since 2007 the first Claimant (Sugar Hut Group Ltd) had held interests in three nightclubs at Fulham, Basildon and Brentwood through its subsidiaries ("the Old Companies"). The first Claimant and certain named subsidiaries, including the Old Companies, were insured against property risks in respect of the above three premises with AXA Insurance (UK) plc by a policy due to expire on 21 March 2009.

On 3 February 2009 the Old Companies went into administration because of financial difficulties. The business of the Old Companies in respect of the three nightclubs was then taken over by the second, third and fourth Claimants ("the New Companies").

The AXA policy was not renewed, and the Claimants obtained cover with the Defendant insurers ("the Defendants") with effect from 21 March 2009. The new policy contained warranties in relation to, amongst other things, the location and inspection/cleaning of kitchen ducting, the burglar alarms and the storage of waste at the Claimants' nightclubs.

A subsequent contract endorsement substituted the New Companies as named insureds in place of the Old Companies, which had gone into administration. It appears that a dispute between the shareholders of Sugar Hut, which involved allegations of siphoning off money and resulted in a Compromise Agreement, may have played a significant part in the financial difficulties.

On 13 September 2009 a fire occurred at the Brentwood nightclub, the cause of which has never been established. The Claimants claimed an indemnity from the Defendants in respect of the substantial loss suffered as a result of the fire.

The Defendants avoided the insurance on the grounds of material non-disclosure and further alleged that the Claimants had breached warranties and conditions precedent in the policy which enabled the Defendants to avoid liability for the claim in any event.

It was admitted that the following facts had not been disclosed to the Defendants: (a) that the Old Companies had gone into administration; (b) that this was due to financial difficulties and (c) that by virtue of the contract endorsement, the New Companies had been substituted as insureds in place of the Old Companies.

The two main issues before the Court were therefore (1) whether the Defendants were entitled to avoid the policy for material non-disclosure and, (2) even if they were not, whether they were entitled to treat themselves as discharged from liability for breach of warranty by the Claimants.

Decision

Non-disclosure

Burton J accepted that the three admittedly undisclosed facts were plainly material. The Claimants also conceded the materiality of the undisclosed facts.

Burton J appeared to acknowledge that a reasonable and prudent underwriter would wish to know whether there is a risk that the financial viability of the business going forward would be endangered, and accepted the evidence of an expert on materiality called by insurers that "a reasonable and prudent underwriter would have asked questions as to why the New Companies were formed, what had happened to the Old Companies and why they were no longer to be the subject of insurance. He would also want to know whether there was a connection between the Old Companies and the New Companies and, if so, whether whatever had gone wrong with the Old Companies would be likely also to go wrong with the New Companies, or whether there was no connection between the Old Companies and the New Companies, in which case he would wish to know whether there was sufficient experience and know-how in the New Companies".

Satisfied that materiality, the first part of the two-stage test in Pan Atlantic Insurance Co Ltd v Pine Top Insurance Co Ltd [1995] 1 AC 501, had been proven Burton J went on to consider whether the Defendants were induced by the non-disclosures, in the sense that they "would not have made the same contract had they known the matters in question". Interestingly, the Claimants did not adduce any factual evidence on the question of why the material facts were not disclosed to insurers. The Defendants contended that, even if they had been made aware of the existence of the New Companies, there was no reason why they would have been able to trade more profitably than the Old Companies who had gone into administration and so they would have been unlikely to accept the risk. The Judge was satisfied that the Defendants would have been unlikely to accept the risk, at least on the same terms, had they been aware of the undisclosed facts, noting that there was "no sign whatever of any over-enthusiasm by [the underwriters] to accept the risk".

Breaches of warranty

In relation to the breaches of warranty, the Court had first to decide whether they were in fact true warranties going to the root of the contract, or whether they were suspensory conditions the effect of which, in the event of a breach, merely suspends the obligation of the insurer during the period of breach. Secondly, the Court had to consider whether the warranties had been breached.

It was held that the warranty in respect of the kitchen ducting and its proximity to combustible materials was a true warranty which had been breached by the Claimants and therefore entitled the Defendants to treat themselves as off risk. The so-called warranty in respect of the six-monthly obligation to inspect and clean the ducting was held to be only a suspensory condition, which had also been breached, and so cover under the policy would have been suspended at the time of the fire due to the late inspection.

It was held that the warranty in respect of the specification and upgrading of the burglar alarm was also a true warranty, one reason being that a burglar alarm compliant with the warranty was of fundamental importance to the theft insurance and was significantly material to the risk of loss. Burton J was satisfied that the alarm installed at the Brentwood nightclub did not meet the standard required under the policy and so the warranty had been breached. This breach also entitled the Defendants to treat themselves as off risk under the policy.

Finally, the Claimants were found not to have breached the obligation to store refuse in non-combustible containers, which was expressed to be a condition precedent to liability. The relevant term had been insufficiently precise in not specifying metal containers, albeit this finding offered little comfort to the policyholder.

Comments

As this case demonstrates, where little or no explanation is given in relation to any changes of name of the insureds either mid-term or at renewal, it may be prudent for an insurer to look carefully into the facts and request further details from the insureds if necessary. The appropriate enquiry would need to take account of any automatic acquisition clause covering newly constituted subsidiaries or inadvertent non-disclosure clause in the wording (neither of which were present in this case). An insurer that believed it was the victim of a non-disclosure would also need to prove inducement, namely that had it been notified of the undisclosed facts it would not have accepted the risk, or would have accepted it but on different terms, in order to be entitled to avoid the policy.

The Court's analysis of the warranties in the policy and the draconian consequences of breach illustrates yet again that any term purporting to be a warranty will be subjected to scrutiny. Where the term can be properly construed in a way that affords an insurer a less severe remedy then it is clear that the Court will be attracted to such an approach.