The Principle of Utmost Good Faith - Essay Example

?Critically evaluate the principle of utmost good faith and the relevant rules derived from the principle in English Law. Discuss the attempts, whichhave recently been made by the Law Commissions to protect the consumers in this area. 1. Introduction When having to face critical legal problems the use of principles of law can lead to the identification of effective solutions – in terms of the benefits achieved but also in terms of the elimination of the relevant risks. On the other hand, the use of these principles cannot always guarantee equality and fairness, meaning the protection provided to the parties involved in the relevant activities. Current paper focuses on the evaluation of the principle of utmost good faith. The specific principle has been related mostly to the insurance law. The introduction of the above principle was considered as a measure for increasing the validity of marine contracts, a target that has been achieved but not fully. The examination of the principles’ aspects led to the assumption that the specific principle has led to the introduction of a series of rules; these rules are critically presented in this paper; appropriate literature and case law have been used in order so show the actual characteristics of the principle of good faith and its implications for the marine insurance contracts, to which the principle of utmost good faith is mostly related. It is concluded that the principle of utmost good faith has played a key role in the increase of validity of marine insurance contracts, at least for the side of insured. The weakness of the principle to provide a clear plan of action when a violation has occurred in regard to one or more terms of the contract involved is clear. The efforts that the Law Commission developed recently in regard to the protection of consumers in the particular field, could help to control the violations in marine insurance contracts – which are critical for the entire market – and to improve the performance of the principle of utmost good faith, as an element of the relevant agreements. 2. Utmost good faith in the English law 2.1 The context of the principle of utmost good faith The principle of utmost good faith has been derived from the principle of good faith – a common element of contracts. For this reason, in order to understand the elements and the rules of the principle of utmost good faith it would be necessary to refer primarily to the framework of the principle of good faith – as used in the common law. The principle of good faith can be characterized as an indispensable element of contracts. The above principle has been recognized as a valuable criterion for deciding on the validity of a contract – especially in cases where the intention of the parties involved is not easily identified.1 In the Scots law, the principle of good faith, or else the ‘bonae fidei’ is a prerequisite for all contracts,2 even if opposite views have been periodically developed.3 Theorists and researchers have used similar approaches in order to describe good faith. In accordance with the most common view, the good faith can be characterized as ‘acting on the assumption of honest dealing’4. The principle of good faith is not accepted as a general principle; it is rather used in specific types of contracts, like ‘the insurance and employment contracts’;5 Conflicts have been often developed regarding the potential value of the principle of good faith for contracts. In Scotland, the most recent trends, lead to the limitation of the necessity of good faith for contracts; however, there are opposite views supporting the value of good faith in contracts. The supporters of good faith in Scotland refer to the need for continuation of civilian traditions, as an argument for promoting the use of good faith in contracts.6 It should be noted that the principle of good faith is not strongly supported in the context of the common law; on the contrary, in the civil law, emphasis is given on the use of the principle of good faith for identifying the level of responsibility of each one of the parties involved in a contract, which has been cancelled.7 The Carter v Boehm case is also analyzed in the study of Hartkamp et al. (2004); in the above study it is explained that the Carter v Boehm case is the key case on which the principle of utmost good faith is based.8 It is noted that the principle of utmost good faith is related mostly to the insurance law – as an opposition from the general law of contract where there is no obligation for good faith.9 Zimmermann et al. (2000) also highlighted the importance of the decision of Lord Mansfield on Carter v Boehm [1766] for the establishment of the principle of utmost good faith; it is further noted that through the above decision, an increased obligation of the insured to disclose all events, which are crucial for a particular insurance contract, is established.10 In accordance with the issues discussed above, the principle of good faith has a particular context; its rules cannot be differentiated but they are rather to be standardized. On the other hand, it has been proved that under certain terms the principle of good faith may not be set as a requirement for accepting the validity of a contract. These issues should be taken into consideration when reviewing the elements and the rules of the principle of utmost good faith, the context of which is analytically described below. The non-acceptance of a general principle of good faith by the common law is made clear in the Walford v Miles case;11 in the above case, it is explained that the acceptance of the principle of good faith in general would lead to severe problems in the British legal system;12 the introduction of such practice would lead to the violation of the fundamental principles of common law, and more specifically of the right of each individual to develop his rights/ interests without being constrained by the will of another party. The principle of the utmost good faith is used in the insurance law. The roots of the principle of utmost good faith can be identified in the 18th century; it was in late the 18th century that lord Mansfield decided to introduce in the English insurance law a principle that could help to resolve disputes related to ‘bad faith or fraudulent insurance contracts’.13 In this context the use of the principle of the good faith was considered as necessary in order to offer a proper interpretation of the intention of the parties in cases of insurance contracts that were under dispute because of their content. The solution was given by lord Mansfield through the introduction of the principle of utmost good faith – based on the principle of good faith.14 It should be noted that the principle of utmost good faith was not introduced – directly – as such concept; rather, the principle of good faith was initially used, and when processing the relevant cases, it was stated that an insurance contract should be ‘not just of good faith (bonae fidei) but rather of utmost good faith (uberrimae fidei)’.15 The principle of utmost good faith was initially used as a principle indicated a requirement ‘stronger than simply the absence of any fraud’.16 The above principle was incorporated in the Marine Insurance Act of 1906 which states that the non-observation of the principle of utmost good faith by either the parties of an insurance contract can give to the other party the right to avoid the contract with no obligation to compensation.17 In accordance with Huybrechts et al. (2000) the principle of utmost good faith was introduced in order to promote fairness in the maritime trade.18 It is explained that the above principle could be described as ‘a situation where the insured has knowledge of facts on the basis of which the underwriter needs to assess the risk and fix the premium’.19 Before the introduction of the above Act, the principle of utmost good faith, as noted above, had been already established through the case law. An indicative example is the Carter v Boehm case (1766) where the judge noted that ‘an insurance contract is a contract of utmost good faith’20. Through the above case, it is made clear that the principle of utmost good faith offers to the insurer a full cover regarding the insurance contract, on the basis that ‘the insurer has to assume that the insured has told him everything about the risk involved’.21 It is from this point of view that the insurer expects from the insured not just good faith, but the utmost good faith.22 In accordance with Stone (2011) in the insurance contracts, when a dispute appear in regard to the non-response of the insurer to the contract, as a result of the non-disclosure of certain facts by the insured, then the issue under discussion is the justification of the insurer’s evaluation on the misrepresentation. In other words, the priority of the Court, in such disputes, is to test whether ‘a reasonable insurer would have relied on the misrepresentation’.23 As noted above, the principle of utmost good faith introduces the rule that the insurer is obliged to disclose to the insurer all facts that can potentially affect the insurance contract;24 at this point, the principle of utmost good faith has a different role compared to the good faith – used in the common contracts. The former establishes the obligation of the insured to inform the insurer on the facts that can potentially affect the terms or the validity of the insurance contract; on the other hand, the principle of good faith does not lead to the obligation of the seller to inform the purchaser on the quality of the good sold;25 this means that in the common contract law – where the principle of good faith can potentially apply, the protection provided to the party who ignores the fault of the object sold is quite low;26 on the contrary, in the insurance law, the insurer is full protected, through the principle of utmost good faith, for any event not disclosed by the insured.27 Moreover, in the context of the principle of utmost good faith the intention or the knowledge of the insured regarding his failure to disclosure is note examined; rather, he is held responsible towards the insurer for all terms of the contract; this means that for any incorrect or false information provided by the insured, the insurer can deny his claims from the contract. 28 The above practice, which is based on the rules on the 1906 Act, has been changed through the Consumer Insurance (Disclosure and Representations) Bill, introduced in May 2011 in the Parliament. Through the years, the nature of the duties incorporated in the principle of utmost good faith has been differentiated. In the past the above principle was mostly related to benefits for the insurer; however, through the modifications made on the 1906 Act by the Law Commission, as described below, the level of protection provided to the consumers entering an insurance policy is increased. 2.2 Rules derived from the principle of utmost good faith The principle of utmost good faith is mainly developed in the insurance sector. The above principle includes a series of rules, which have been revealed in cases where the specific principle was set under examination. The case law will be used along with the literature in order to highlight the rules of the specific principle. In the context of the utmost good faith, as described above, the insured needs ‘to disclosed all facts which can affect the premium or the risk of a particular insurance contract’;29 the failure of the insured to act accordingly, can lead to the right of the insurer to ask for the contract to be declared as void.30 The above issue has been judged by the Court in the case of Banque Keyser Ullmann SA v Skandia (UK) Insurance;31 in the above case the Court held that the failure of the insured to disclose the facts that could influence the level of the premium gives to the insurer the right to refuse meeting its obligations – as derived from the particular contract; however, still, the insurer could ask for his funds to be transferred in another financial institution. In accordance with the above, one of the rules of utmost good faith is the obligation of the insurer to disclose the facts having the power to influence the insurance contract.32 The option of the insurer ‘to render the contract voidable’33 – in case that the insurer fails to disclose all facts that influence an insurance contract is another rule of the principle of utmost good faith. In accordance with Hodges (1999) the principle of utmost good faith can be related to a series of rules: a) the facts disclosed by the insured need to be specific regarding the time and the place that the risk expected would appear;34 this issue was highlighted by the Court in the case Manifest Shipping and Co Ltd v Uni-Polaris Insurance Co Ltd;35 b) the information disclosed by the insured needs to be such that it can allow the insurer to take a decision regarding the insurance contract involved;36 in the case Fraser Shipping Ltd v Colton and Others, the insured had failed to provide to the insurer the necessary information on the change of the voyage and the subsequent increase of risk for the vessel; the Court has held that the disclosure of false information should be regarded as similar to the non-disclosure of information.37 The obligation of disclosure as developed in the context of the insurance law can be also used in corporate transactions; this fact is highlighted in the study of Spedding (2008) where reference is made to the ability of the parties of a corporate transaction to include in their contract the obligation for utmost good faith.38 Through the above term, a ‘duty for disclosure’39 is established in regard to all the facts of which the parties are aware. In accordance with the above, the rules of utmost good faith are applicable on all agreements where the specific principle is incorporated. Under certain terms, conflicts may be developed regarding the potential interpretation of the principle of utmost good faith in regard to a specific insurance contract. Such case is mentioned in the study of Birds (2010). The above researcher notes that, under normal terms, the principle of utmost good faith can lead to the right of the insurer for ‘avoiding the contract from the beginning’.40 This is the case of the fraudulent behaviour by the insured. In the case law, it has been accepted that in the case of fraudulent behaviour of the insured, the insurer can deny his claim to which the fraud is related.41 2.3 The recent attempts of the Law Commissions to protect the customers in this area The principle of the utmost good faith, as developed in the common law, introduces significant advantages for the insurer. In practice, such perspective is negative for insured. The need for the introduction of schemes that would protect the insured from the potential violation of his rights – in case that the insurer would make use of the principle of utmost good faith with no ethical justification – is emergent. The contracts, which have a standard form, can also threaten the rights of individuals who proceed to a contractual agreement using such contract – reference is made especially to the case of the insurance law where the principle of utmost good faith is used for protecting the rights of the insurer.42 Scott et al. (2000) note that adding in the relevant contractual agreement the term for meeting ‘the good faith provision of the EC Directive on Unfair Terms in Consumer Contracts’43 – since in this way its benefits from the principle of utmost good faith would be reduced – the Law Commission has developed a series of initiatives for protecting the rights of individuals who enter contracts that are based on the principle of utmost good faith.44 In May 2008, the Law Commission published a paper/ report suggesting the abolition of the obligation of consumers for the voluntary provision of information when entering an insurance contract.45 In 2009, the Law Commission has drafted a Bill aiming to set limits in the power of the insurer as resulted from the principle of the utmost good faith. The principle, which has the title ‘the Consumer Insurance (Disclosure and Representations) Bill’46 deletes, in practice, the principle of the utmost good faith and requires from the insurer to make specific questions in regard to the facts that are critical for the validity of the contract. The Consumer Insurance (Disclosure and Representations) Bill ‘was introduced in Parliament on 16 May 2011’ (Law Commission 2011). The above Bill includes a series of rules, which explain the disclosure obligations of consumers in case they decide to proceed to an insurance policy (Law Commission 2011); in other words, the Bill aims to ensure that those entering an insurance policy will be appropriately informed on their obligation for disclosure towards the insurer. Indeed, through the above Bill, a series of gaps of the 1906 Act are effectively covered: a) in the 1906 Act the obligation of the insured for disclosure was not clear; many consumers were not aware of the existence of such obligation; as a result, they used to enter an insurance policy without being aware of the fact that the insurer could ask for the breach of the contract – as a result of failures in the insured disclosure, b) consumers were not protected against the insurer; even ‘when the consumers have acted honestly’ (Law Commission 2011) the insurer could deny their claims on the basis that a failure could be identify in regard to their disclosure, c) the potentials of the insurer to deny the claims of the insured were extensive including the case of a mistake by the consumers’ side, a term which can be characterized as quite unfair taking into consideration the fact that the existence of minor mistakes in a contract – as in every document – is always possible, d) from the same point of view, the right of the insurer to deny the claims of the insured even if there is a statement which is not correct, is not justified (Law Commission, Consumer Insurance, 2011). The above problems have been effectively addressed through the Consumer Insurance (Disclosure and Representations) Bill. The weaknesses of the 1906 Act were made clear in the case of Lambert v Co-operative Insurance Society Ltd [1975]; when developing the insurance policy – in relation to the insurance of her jewellery - Mrs. Lambert did not mention to the insured the convictions of her husband as she was not aware of the necessity of such statement; when Mrs. Lambert asked for compensation for her lost jewellery, the insurer denied her claim because of her failure to mention the convictions of her husband. The court decided that the insurer had any right to deny the claims of Mrs. Lambert, even if such decision would be considered as unfair (Law Commission, Consumer Insurance 2011). On the other hand, the Consumer Insurance (Disclosure and Representations) Bill helps to integrate the legislation focusing on the regulation of the Insurance policies; because the 1906 Act did not include sufficient rules for regulating disputes referring to the specific sector, consumers had to seek for assistance in the FSA (Financial Service Authority) and the FOS (Financial Ombudsman Service); this fact had led to the increase of complexity of the procedure and the limitation of the power of consumers to ask for their rights – consumers who decided to address FOS could not use, simultaneously, the Courts. Moreover, the relevant procedure was not clear, leading to mistakes regarding the rules used for supporting claims (Law Commission, Consumer Insurance 2011). 3. Conclusion The principle of utmost good faith has been used in order to serve a series of needs, in the context described above; through the years it has been made clear that the above principle promotes mostly the interests of the insurer – referring specifically to the case of the insurance contracts where the principle of utmost good faith is extensively used. On the other hand, it could be noted that such outcome would be unavoidable due to the lack of alternative for the insurer to protect his rights. More specifically, without the specific principle the insurer would be exposed to high risks, since it would not be feasible for the insurer to check the credibility of the statements of the insured in regard to the facts that are important for developing the insurance contract.47 Despite the value of the principle of utmost good faith as a tool for ensuring equality in contractual agreement – especially the insurance contracts – still, its use leads to conflicts and oppositions mostly because the protection provided to one party, the insurer, is greater compared to that provided to the other party, the insured. The initiatives developed by the Law Commission are important towards the elimination of the inequalities caused because of the principle of utmost good faith48; the Consumer Insurance (Disclosure and Representations) Bill which was introduced in Parliament in May of 2011 covers many of the gaps of the 1906 Act – as explained above. In the context of the above Bill, consumers in insurance policies are more protected; moreover, the principle of utmost good faith is no more the vehicle for the provision of extensive rights in favour of the insurer, a fact, which increases the fairness of the existing Insurance law. References A. Books Beale, H., Bishop, W., Furmston, M. 2007. Contract: cases and materials. New York: Oxford University Press Beatson, J., Friedmann, D. 1997. Good faith and fault in contract law. New York: Oxford University Press Birds, J. 2010. Insurance Law in the United Kingdom. The Hague: Kluwer Law International Forte, A. 1999. Good faith in contract and property. Oxford: Hart Publishing Grundmann, S., Mazeaud, D. 2006. General clauses and standards in European contract law: comparative law, EC law and contract law codification. The Hague: Kluwer Law International Hartkamp, A., Hondius, E. 2004. Towards a European civil code. The Hague: Kluwer Law International Hodges, S. 1999. Cases and materials on marine insurance law. London: Routledge Huybrechts, M., Hooydonk, E., Dieryck, C. 2000. Marine Insurance at the Turn of the Millennium. Oxford: Intersentia Keenan, D. 2007. Smith & Keenan's English law: text and cases. Essex: Pearson Education Mandaraka-Sheppard, A. 2007. Modern maritime law and risk management. London: Routledge Niekerk, V. 1998. The development of the principles of insurance law in the Netherlands from 1500 to 1800. Hilversum:Uitgeverij Verloren Oughton, D., Davis, M. 2000. Sourcebook on Contract Law. London: Routledge Purvis, K. 2010. English insurance texts - Words for the week. Stuttgart: Verlag Versicherungswirtsch Purvis, K. 2000. English for the insurance industry. Stuttgart: Verlag Versicherungswirtsch Scott, C., Black, J., Cranston, R. 2000. Cranston's consumers and the law. Cambridge University Press Smits, J. 2002. The making of European private law: toward a ius commune europaeum as a mixed legal system. Oxford: Intersentia Spedding, L. 2008. The due diligence handbook: corporate governance, risk management and business planning. Oxford: Butterworth-Heinemann Stempel, J. 1999. Law of insurance contract disputes. New York: Aspen Publishers Online Stone, R. 2011. The Modern Law of Contact: Ninth Edition. Oxon: Taylor & Francis Twigg-Flesner, C. 2010. The Cambridge Companion to European Union Private Law. Cambridge: Cambridge University Press Wessels, B. 2004. Current topics of international insolvency law. The Hague: Kluwer Law International Zimmermann, R., Whittaker, S. 2000. Good faith in European contract law. Cambridge: Cambridge University Press B.Journals Clarke, M. 1989. Insurance Fraud. British Journal of Criminology. 29 (1): pp.1-20. Law Commission. 2009. Review of Insurance Contract Law. Available from Law Commission. 2008. Reforming Insurance Contract Law. 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Sun Alliance London Insurance [2002] ScotCS 141 (21st May, 2002) CPC Group Ltd v Qatari Diar Real Estate Investment Company [2010] EWHC 1535 (Ch) (25 June 2010) Drake Insurance Plc v Provident Insurance Plc [2003] EWCA Civ 1834 (17 December 2003) Fraser Shipping Ltd v Colton and Others [1997] Haugesund Kommune & Anor v DEPFA ACS Bank [2009] EWHC 2227 (Comm) (04 September 2009) HIH Casualty & General Insurance Ltd v New Hampshire Insurance Company & Ors [2001] EWCA Civ 735 (21 May 2001) HIH Casualty and General Insurance Ltd & Ors v Chase Manhattan Bank & Ors [2003] UKHL 6 (20 February 2003) Hoechst Marion Roussel Ltd. & Ors v Kirin-Amgen Inc. & Ors [2002] EWHC 471 (Patents) (21st March, 2002) Manifest Shipping Co Ltd v Uni-Polaris Shipping Company Ltd & Anor [1996] EWCA Civ 1279 (20th December, 1996) McAlinden & Anor, Re Judicial Review [2009] NICA 56 (7 December 2009) Meares v. Medway Primary Care Trust [2010] UKEAT 0065_10_0712 (7 December 2010) Medforth v Blake & Ors [1999] EWCA Civ 1482 (26 May 1999) Mylcrist Builders Ltd v Buck [2008] EWHC 2172 (TCC) (19 September 2008) National Westminster Bank Plc v Rabobank Nederland [2007] EWHC 1056 (Comm) (11 May 2007) Office of Fair Trading v Abbey National Plc & 7 Ors [2008] EWHC 875 (Comm) (24 April 2008) Premier Mortgage Connections Ltd v. Miller [2007] UKEAT 0113_07_0211 (02 November 2007) Prudential Staff Pensions Ltd v The Prudential Assurance Company Ltd & Ors [2011] EWHC 960 (Ch) (14 April 2011) Socimer International Bank Ltd v Standard Bank London Ltd [2008] EWCA Civ 116 (22 February 2008) Street v Derbyshire Unemployed Workers' Centre [2004] EWCA Civ 964 (21 July 2004) Read More