It has long been established that the duty of good faith is one which continues after the contract of insurance has been formed. The extent of the duty, however, will vary depending on the stages in the contractual relationship. The duty is strongest before the contract is formed. But the insured remains under an obligation to disclose all material information relating to the claim – if the insured acts fraudulently, the insurer can avoid the claim.

Where the conduct of the insured is not fraudulent, it has been less certain whether the remedy of avoidance will be granted to an insurer. Although an innocent misrepresentation or non-disclosure on the part of the insured in the claims process will not normally defeat a claim, it is usually the case that the insured should always act as if the duty of utmost good faith continues. But what happens when the insured sues the insurer? Here, the parties are no longer dealing with each other in an open way as required by the doctrine of good faith. The question arises: if the insurer denies liability and compels the insured to bring proceedings, do the parties remain subject to a continuing duty of good faith?

The House of Lords considered this important question in the recent case of Manifest Shipping Company v Uni-Polaris Shipping Company and Others.


Facts and Dispute

On November 8, 1989, brokers acting for the Kollakis group of companies renewed for another year the marine hull and machinery cover on 40 vessels in their fleet, including the Star Sea. Before sailing on November 28, 1989, the Star Sea had been inspected by a class surveyor and her cargo ship safety certificate, covering among other things fire safety, was renewed. The renewal insurance cover was added on November 25, 1989, the vessel's insured value was $3.2m (£2.2m). The insurance was governed by English law and so the provisions of the Marine Insurance Act 1906 applied. Loss by fire was a peril insured against.

On May 27, 1990, the Star Sea sailed from Nicaragua to Zeebrugge. On May 29 a fire was accidentally started in the engine-room workshop. Repeated attempts were made to extinguish the fire but when it was eventually put out the damage was so extensive that the vessel had become a constructive total loss.

Notice of abandonment was given to the insurers on June 12, 1990, but was not accepted. Manifest Shipping sued the insurers.

The insurers relied on two defences: section 39(5) of the act, which is concerned with the unseaworthiness of the vessel and the extent to which the insured was “privy” to such unseaworthiness, and section 17 of the act, which relates to the insured's duty of utmost good faith. Only the second defence will be considered in this article.

The insurers argued that the insured was under a continuing duty of utmost good faith to disclose to them any information material to the claim and which might affect their decision to pay or defend the claim. They contended that the insured owed them this duty even though litigation had started.

They also argued that the duty had been breached by the insured's failure to disclose certain facts material to the defence. Accordingly, the insurers said that they were entitled to avoid the whole contract ab initio [from the beginning] and therefore had a complete defence to the whole of the claim, both the constructive total loss claim and the partial loss claim.

At first instance, Tuckey J had held that this defence failed – both in law and on the facts – and gave judgment for the insured and limited the partial loss to $1.7m (£1.2m). The Court of Appeal dismissed the insurers' appeal and the insurers appealed to the House of Lords.


House of Lords Decision

The court held that there was no duty upon the insured to make a full disclosure of its case to the other side in litigation. Lord Clyde said: “Unlike the initial stage when the insurer may rely very substantially upon the openness of the insured in order to decide whether or not to agree to provide insurance cover, the insurer has open to him means of discovery of any facts which he requires to know for his defence to the claim. The idea of a requirement for full disclosure superseding the procedural controls for discovery in litigation is curious and unattractive and one which would require and be soundly based in authority or principle.”

The court concluded that the substance of the obligation of good faith could vary according to the context in which the matter was being decided. It stated that it was reasonable to expect a very high degree of openness at the stage of the formation of the contract, but that there was no justification for expecting that degree of openness to continue once the contract had been made.


Avoiding the issue

Section 17 of the Act says: “A contract of marine insurance is a contract based upon the utmost good faith and, if the utmost good faith be not observed by either party, the contract may be avoided by the other party…”

The act places no express limitation upon the period over which the obligation of good faith should extend, nor does it limit the degree of disclosure to be given by the parties. The Lords was reluctant to impose a limit upon the period of the relationship between the parties to which section 17 was meant to apply so that it would only apply to pre-contract negotiations. Instead, the court was flexible in its interpretation of the concept of utmost good faith and expressly reiterated what was already considered to be the case, namely that a lesser degree of openness was required at the stage of a disputed claim.

The duty of good faith does not cease – the extent to which the parties are bound by it merely varies at the different stages in their contractual relationship. The parties' disclosure obligations therefore will vary in their content and substance according to the circumstances. Once proceedings have been issued, the duty of disclosure on the insured will be less onerous and the insured will be obliged to disclose only those documents which it is obliged to disclose in the ordinary course of disclosure.


Implications

The outcome of the case means insurers should:

  • insist that the contract specifically provides that the insured must supply the insurer with clear and unambiguous proof that the loss has occurred in the amount claimed
  • expressly provide that all proofs and all information with respect to the claim as may reasonably be required by the insurer should be provided as soon as reasonably practicable or within a specified timescale
  • insist (although it is not strictly necessary) that the clause be expressed to be a condition precedent to payment by the insurer. If it is a condition precedent, the insurer may refuse payment, even though the insurer has suffered no prejudice by the breach.

    In the case of reinsurance contracts, the same difficulties regarding disclosure could arise. Reinsurers should try to enforce their full contractual rights of inspection as soon as they are notified of a claim. They should consider inserting an express provision in the contract when agreeing the terms to the effect that no proceedings will be issued by either party until insurers have been afforded the opportunity to inspect all books and records of the insured in accordance with their express or implied contractual rights.


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