Supreme Court: 'collateral' lies not necessarily fatal to insurance claim

Overturning the decision of two lower courts, the Supreme Court ruled by a majority of four judges to one to uphold the claim, as the 'collateral' lie told by the owner turned out to be irrelevant.

Insurance law expert Nick Bradley of Pinsent Masons, the law firm behind Out-Law.com, said that the judgment would be seen by some as "pushing the pendulum too far in favour of insureds" at a time when insurance law in England was about to undergo its most significant changes in over a century.

"In just two weeks time, the new Insurance Act will come into force and will be applicable to all insurance and reinsurance contracts governed by English law coming into effect on or after 12 August," he said. "The reforms will bring UK insurance law up to date, and are considerably more 'insured friendly' than the old regime. They have also been roundly welcomed by the insurance industry as reflecting good modern practice, and give us a legal framework fit for insurance in the 21st century."

"In marked contrast, many insurers may well take the view that this latest change in the law, by four of the law lords, pushes the pendulum too far in favour of insureds. The view of the dissenting judge, Lord Mance, was that there is a strong public policy against fraud, so unless the fraudulent device was immaterial, insurers should be able to reject such claims. This has the attraction of a more common sense approach, and is consistent with the approach taken by the Law Commission and adopted by the new Insurance Act, which expressly recognises the importance of disallowing fraudulent claims," he said.

Insurers might want to consider putting express provisions in policies to make it clear that the insurer was able to decline a claim supported by a so-called 'fraudulent device' given this decision, Bradley said. However, these clauses would need to take into account the 'contracting out' provisions of that Act, which apply only to commercial insurance contracts and require the clauses to be clear in meaning and as to effect, and drawn sufficiently to the attention of the insured party, he said.

Versloot Dredging BV, a Dutch shipping company, had appealed a decision by their insurers to refuse their claim for damage caused when the engine room of DC Merwestone was flooded at sea and the engine damaged beyond repair. The insurers had denied liability on a number of grounds, including that the company had told a reckless untruth in support of their claim in order to make them appear less at fault. Versloot had told them that the crew had informed them that an alarm had sounded earlier that day, but that they could not investigate further due to weather conditions.

The damage was ultimately found to have been caused by the conditions at sea, making whether or not the crew had investigated an alarm irrelevant to the claim. However, both the trial judge and Court of Appeal ruled that the lie was a "fraudulent device", which meant that the insurers did not have to pay out under the policy. A fraudulent device differs from a fraudulent claim, which is one that has been fabricated or dishonestly exaggerated and which an insurer is always entitled to avoid.

Giving the judgment of the court, Lord Sumption said that there was "an obvious and important difference between a fraudulently exaggerated claim and a justified claim supported by collateral lies".

"Where a claim has been fraudulently exaggerated, the insured's dishonesty is calculated to get him something to which he is not entitled," he said. "The position is different where the insured is trying to obtain no more than the law regards as his entitlement and the lie is irrelevant to the existence or amount of that entitlement."

"I do not accept that a policy of deterrence justifies the application of the fraudulent claim rule in this situation. The law deprecates fraud in all circumstances, but the fraudulent claim rule is particular to contracts of insurance. It reflects ... the law's traditional concern with the informational asymmetry of the contractual relationship, and the consequent vulnerability of insurers. It is therefore right to ask in a case of collateral lies uttered in support of a valid claim, against what should the insurer be protected by the application of the fraudulent claims rule? It would, as it seems to me, serve only to protect him from the obligation to pay, or to pay earlier, an indemnity for which he has been liable in law ever since the loss was suffered," he said.

In a supporting judgment, Lord Hughes said that this conclusion was not inconsistent with the Insurance Act, which "separate[s] the duty of good faith from the law relating to fraudulent claims".

"[The Act] … preserves the rule that the fraudulent claimant recovers nothing, including any unexaggerated element," he said. "But [it] deliberately leaves open the scope of the fraudulent claims rule, and in particular leaves open the present issue as to whether it extends to fraudulent devices. It was clearly contemplated by parliament that the courts would in due course resolve this question."

However, in his dissenting judgment, Lord Mance said that suggesting that a lie "which the insured felt necessary to promote settlement of a claim" was merely 'collateral' in nature "mistakes the nature of the business and the relationship" of an insurance contract.

"On the contrary, since the lie is told to influence the underwriter's assessment of what a court would decide and thereby to induce the underwriter to pay the claim, its materiality can perfectly well be, and must in my view be, based on its relevance to that assessment and to the underwriter's decision whether to pay," he said.

"Abolishing the fraudulent devices rule means that claimants pursuing a bad, exaggerated or questionable claim can tell lies with virtual impunity … In the relatively rare case, like the present, where the insured pursues a claim to trial, and is found after the event to have had a sound claim, it may seem harsh that the insured loses everything. But policy must be definition look at the position overall, as the core fraudulent claims rule does. In any event a person who uses fraudulent devices in the context of an insurance relationship deserves no real sympathy," he said.

Financial services litigation expert Michael Ruck of Pinsent Masons said that although it might "seem somewhat at odds with natural justice to suggest that someone who puts in an insurance claim for a stolen computer worth £1,000, but who fabricates a receipt for that amount, would still have a valid claim", the proper question to be asked in these circumstances was "what the true value of the claim may be".

"Only time will tell if insurance payouts and premiums both rise as a result of the Supreme Court's decision," he said.