The Duty of Utmost Good Faith in the Contract of Insurance - Research Paper Example

A CRITICAL DISCUSSION OF THE DUTY OF UTMOST GOOD FAITH IN THE CONTRACT OF INSURANCE Introduction Utmost good faith is animportant requirement in pursuing insurance contracts. The doctrine requires the insured party to such contract to disclose all vital and relevant information that could reinforce the insurer’s knowledge of the incoming client.1 Consequently, the insurer uses such information to design individualised packages for cases that require different levels of commitment. The doctrine of utmost good faith has limited to no applicability outside the insurance sector. In particular, it is overtaken by numerous developments within the general law of contract.2 This essay discusses the relevance of the doctrine of utmost good faith in the face of a fast-changing business environment that requires flexibility and equal commitment from all parties to a contract. In order to achieve this, the author provides a background to the topic, and discusses the application of the doctrine in face of both the insurance and contract laws. Stages of the contract process are then interrogated to seek the different and similar requirements that necessitate application of the doctrine. Further, the views of scholars on the doctrine are explored so as to shed light on the apparent controversy that the doctrine has created among researchers and practitioners. The author remarks that the explored literature does not provide a strong basis to warrant a review of the doctrine. Consequently, its applicability in insurance law should remain as it is, even as more modern provisions of law are sought. Discussion Background The U.K. has some of the oldest, formalized insurance laws governing the insurance sector. The law on insurance has been evolving fast over the last century, with major developments intended to rhyme with the evolving geo-political scenes taking centre stage.3 For instance, the Maritime Insurance Act (1906) has recently been overhauled and the Consumer Insurance (Disclosure and Representations) Act (2012) enacted as the industry’s new regulatory framework in order to respond to a growing significance of previously non-existent industries and harmonize the various provisions of the insurance law.4 While different countries have adopted slightly varying versions of the insurance law, the maritime insurance law appears to follow a close-global script. The general script is largely similar to the UK Marine Insurance Act (1906) whose framework has been widely consulted to create equally competent laws for insurance industries in other jurisdictions.5 Perhaps this apparent similarity in the way different jurisdictions draft their maritime laws is necessitated by the many boldly binding agreements that govern trade in a largely global environment. Yet one aspect of the maritime law sticks out for its apparent rigidity and the obvious inflexibility that has enabled it persevere more than a century without tangible amendments.6 The Marine Insurance Act (1906) lays down several aspects of law that govern insurance of maritime cargo and the carriers (ships or any insurable sea vessels). Section 17 is of particular interest to scholars, insurers and the legal sphere for its specificity to the field of insurance.7 The section, touching on the principle of utmost good faith outlines what the insured is supposed to disclose to the insurer at the time of entering an insurance contract.89 Loosely explained from the dimension of an individual intending to take up a life policy (life insurance), the potential insured is obligated by the principle of utmost good faith to disclose all information relating to their health status at that moment, and further delve into past medical/ health history.10 The basis for this requirement is to make the insurer aware of the level of risk associated with taking any of the clients they insure. General practice follows a systematic procedure that classifies clients based on the risk index. The higher the risk, the more the potential cost of the service to the insured.11 Ranking effectively places the insurer at lesser risk of losing out too much value for the cost of service extended to the insured. Inevitably, the associated high cost is passed on to the consumer. Consequently, many insurance companies adopt strategic information-based criteria for valuing the potential cost of providing service to consumers with different requirements – sometimes seen as loose regulation of premium ceilings.12 In the absence of such criteria-based evaluation system the company would be compelled to charge standard fees for non-similar situations, obviously disregarding the significance of the varying characteristics among the consumers, including their individualized needs.13 Utmost Good Faith in the Context of Insurance and Contract Law Generally, utmost good faith presents an essential part of any type of contract. However, based on the field from which we are evaluating it, it may not be necessary that the parties in question take it into consideration while engaging each other at any part of the contract. Still, there are instances where the service provider bears more relevance in terms of the requirement to disclose material information to the potential service recipient. For instance, when entering a sale contract, the buyer has minimal obligation to disclose any material information. In essence, the law considers that they possess minimum knowledge of the product being sold.14 However, the buyer in such case can still be said to breach the doctrine by making claims that could unnecessarily lower the value of the property being sold. However, this type of misrepresentation of facts at the initial stages of an ordinary business contract (like say the sale of a house) does not necessarily constitute a breach of the doctrine of utmost good faith.15 Yet the same cannot be said if the said misrepresentation was done in an insurance contract. A comparable case to that described above is one where the potential insured holds back information in order to make their case appear ‘just normal’ and not warranting extra caution by the insurer.16 In such a case, the insurer is bound to be duped into entering the contract with the full knowledge that would enable them make better choices for the client, or even decline the offer to enter the contract. Clearly, the parties have different roles in respect of the type of contract being negotiated. Another fair example is one in which a medical doctor enters a contract to treat a sick person. The sick person has the obligation to disclose important details about how they are feeling and any symptoms they have observed up to that moment. In addition, they are required to update the doctor with records of other diseases/ conditions they could have suffered in the past which may be relevant in evaluating the present case. In view of the above circumstance, the role of the service recipient in providing a fair and honest picture of how they feel is not always binding. Based on the situation, they may not even be able to make any conscious decisions on their own. The doctor, being a professional, is required to make a professional and fair assessment of the situation and undertake or recommend service provision immediately. In this case, the burden of proving honesty lies with the expert (professional) since even in instances where the patient is capable of describing how they feel, they are not experts and they cannot make recommendations on what they can be treated for or how they will be treated. The doctor is then obliged to make clear and honest disclosures of their assessment that led to the pattern of medication/ treatment preferred.17 Clearly, parties to a non-insurance contract have different duties of disclosure as opposed to those born by similar parties entering an insurance contract. Stages of the Contract Process and Duties of Disclosure There are three major stages in the contract process. Each stage presents a different set of requirements for the insured to make additional disclosures or fail to make any. The three stages are discussed below. Pre-contractual Stage. The pre-contractual stage is the most important when considering the role of the doctrine of utmost good faith in an insurance context. The stage involves what can be termed as ‘negotiations’ to agree on how the insurer is going to charge (based on considerations emanating from the disclosures of the insured), the terms of the policy, the expectations from each party, and explanation of any facts that the insurer feels are important to the insured, sometimes based on whether the latter goes ahead to inquire.18 Notably, any decisions made after this phase could be considered irrelevant, especially since the law does not oblige the insured to constantly update the insurer about possible developments that could be subsequently material to the contract.19 This is because, as much as the doctrine of utmost good faith requires the insured to make honest disclosures, the contract so signed is solely based on the status of the insured (and the property that they could be intending to insure) and not on what becomes of them at a later stage. However, there are exceptions to this rule where the insured’s property gets damaged from agents that were not highlighted as a possible cause of making a claim. Post-contractual Process. The post-contractual process constitutes any processes initiated or sustained within that time after the parties (insurer and the insured) have entered a contract. The conduct of each party is still bound by the binding agreement they entered. However, there are possibilities that upcoming issues/ matters could wreck the core of the agreement and lead to its subsequent invalidity.20 For instance, when the insured does acts that violate the warranty provided for in the agreement terms, the law deems the agreement as being null and void from the moment the violation is discovered or the time from which the violation is established to have been existing. It is essential to note that the insurer is not bound by their pre-signed obligation to annul payment and even cancel the pre-existing contract.21 The slight difference in the legal provisions governing the relationship is the result of the Consumer Insurance (Disclosure and Representations) Act (2012) that repealed the provisions of the Marine insurance Act (1906). The provisions of the more recent Act reveal that the law has subsequently tried to offer a balance between the buyer and the seller in terms of their liability under the doctrine of utmost good faith. The insured is no longer the sole bearer of disproportionate allocation of power in law. While the insurer was almost always the beneficiary of misinformed policy follow-up by the insured (for instance, based on the fact that the insurer and all his agents are well trained and have better knowledge of the provisions of the insurance law and their matching implications), the new law requires both parties to play equal roles in ensuring that they provide honest positions of their standing. For instance, it is wrong for an agent of the insurer to fail to disclose fundamental facts that the insured alludes to, and that could lead to future annulment of the contract, or that could render the initial contract null and void right from the onset of the contract.22 The Claim Process. The claim process is initiated when the insured party suffers a loss to their vessel or cargo. The process is sometimes long and resource consuming, with parties having to settle disputes in court over disagreeing accounts of facts.23 The disagreement in facts can be due to several issues. Furthermore, the basis for the contradiction could have been borne right at the time of entering the contract. This is where the doctrine of utmost good faith gains entry into seeking permanent settlements to insurance disputes. As indicated, the time that parties entered a contract marks the first possible point of misrepresentation of facts that could be deemed as a breach of the doctrine of utmost good faith. Misrepresentation of facts that eventually becomes apparent is one such cases. Misrepresentation is in such a case viewed as the intentional falsification or concealment of facts and information in an attempt to misguide and coerce the insurer into entering an insurance contract. In law, misrepresentation is a false/ inaccurate statement of fact made by a party to an agreement before signing.24 The law recognises that the individual accused of misrepresentation could have made a deliberate or unintentional offence. As such, the grounds on which misrepresentation occurs must be established under the categories: Misrepresentation for purposes of committing fraud, Misrepresentation on the basis of a party’s negligence, or Misrepresentation done innocently.25 Falsified disclosures that are intended to persuade a party to enter a deal are guarded against in the Misrepresentation Act (1967). Such misrepresentation is considered adequate grounds for one party to initiate cancellation or termination of the contract so entered.26 The basic criteria for identifying a misrepresentation as fraudulent involves establishing that the party knew the information they provided was untrue, gave the information without believing it is true, and they recklessly presented the information. Notably, this claim can be made on the basis of negligence, majorly emanating from failure to investigate the truth where there are sufficient grounds to believe that the individual was at a position to know or acquire information by the time they made the misrepresentation.27 Besides cancelling such a contract, the insurer can also go ahead to claim damages on the basis of wasted resources, wasted time and potential threat to company’s reputation. The Act bestows upon the person accused of misrepresentation (the insured) the role of disapproving that they either acted negligently or were aware that they provided untrue information. Negligent misrepresentation occurs when facts are provided in a reckless manner or when the person presenting them did not have reasonable grounds to believe that what they said was true. While such crime may be tried under the Misrepresentation Act (1967), it is also worthwhile to note that the offence of negligence is substantially covered in the Law of Tort, presenting an alternative avenue to handle this class of offences. Recovery of damages is not guaranteed, even when sufficient grounds to believe that the insured was negligent in their duty have been established.28 On the other hand, Section 2(2) of the Misrepresentation Act (1967) provides that if the insured had reasonable grounds to believe that the information they provided was factual, the law recognises that they did not err at will, and the court will likely settle for lighter sentence, including awarding damages at the very worst, or restoring both parties to their original state before the contract was entered (cancelling the contract without awarding damages, especially if the insurer does not prove that they suffered losses due to the mistake of the insured). Law Scholars’ Views on the Doctrine of Utmost Good Faith The doctrine of utmost good faith is widely covered in present-day literature. The wide coverage shows not only the enthusiasm that scholars have for this topic but also the potential contradictions it draws as practitioners explore the different schools of thought arguing both for and against its existence. The relevance of the doctrine appears to be at stake; at least borrowing from the views of such research authors as Rupert Cohen and Christopher Butcher. On the one side, Butcher appears to suggest that overhauling or even replacing the doctrine would make the insurance sector as competitive as other sectors of the economy. In his view, the banking sector is the right example that the insurance providers should critically evaluate in order to learn some valuable lessons regarding revolutionizing services alongside the terms of engagement with clients.29 Butcher is almost convinced that the insurance sector has been laden with rigidity, which has hampered growth and given it a bad image to the population. Citing several other UK laws that have been systematically phased out to pave way for trendy, change-responsive legal provisions, Butcher insists that the doctrine of utmost good faith has remained unchallenged mainly because the population has significantly limited knowledge about the entire sector. Cohen’s argument is largely centred on the general outlook of the doctrine from the consumer’s perspective. He asserts that the doctrine is not only outdated but also draconian, built upon principles that governed the population at a time when the law substantially asserted the authority of the ruling, moneyed class over the poor masses. The author agrees with industry’s figureheads that the aspect of disclosure is an important part of any negotiation, if parties are to trust each other in future.30 However, by implying that the perfect degree of honesty required for insurance cover is merely done ‘in good faith’ is equated to a ‘fallacy’. The mood preceding the disclosure is either unconsidered or ignored, resulting in a falsified labelling of the compelled disclosure as one of good faith.31 Consequently, Cohen believes that the term ‘utmost good faith’ is the wrong description for a compelled disclosure of facts, and should be replaced by other more situation-reflective terms such as ‘minimal disclosure requirements’ and ‘duty of honesty’. Needing particular attention is the difference between giving out information on personal volition and having top provide the same out of the fear that failure to comply with disclosure requirements will automatically lead to policy withdrawal and even classification as an untruthful, uninsurable individual. The researcher further takes interest in how any slight violation of the requirements for disclosure could be punished by the remedy of avoidance. Avoidance is the intentional and notice-free vacation of a party from a contract based on the other party’s failure to comply with certain or all of the terms of an agreement.3233 Such failure could be the violation of the binding agreement, or simply detection of flawed information given at the pre-contract stage. The remedy of avoidance has been associated increased ease of abdication of roles by the insurers. The level of honesty required is not uniform and the law has all along given the insurers the upper hand in deciding settlements. As a result, some insurance companies have invested in seeking ways to annul contracts that have potential loopholes for termination. On top of inciting low trust from the consumers, these tendencies have highlighted the doctrine as a potential threat to the industry. Instead, Cohen argues that the insurers should be compelled to provide a reliable (possibly generic) form that potential insureds could be given to avoid potential exploitation of loopholes associated with issuance of unguided forms to record all information that is material to the insurer. Woloniecki explores the relevance of the doctrine of utmost good faith from the dimension of effectiveness (or lack of it). In his assessment of the positions of both the insured and the insurer, the author notes that each party has an obligation to present facts in an honest way; with the insured disclosing material information that will help the insurer determine accurately the right classification to tag them into, and the insurer presenting an honest position of whether the information provided by the insured is sufficient or accurate enough to guarantee a cover policy.34 Yet this is not what always happens. Woloniecki is concerned that parties do not appear keen to disclose honest information and positions regarding themselves, a situation that makes either parties vulnerable to a fraudulent claim or voidance of contract. Referring back to the case of Carter v Boehm, Woloniecki noted that the duty of disclosure under the doctrine of utmost good faith is only relevant during the pre-contract period, after which it is overtaken by events and becomes non-binding for the insured to disclose any further information regarding developments occurring thereafter. The author argues that if utmost good faith was to be ethically carried across on a personal volition basis, then parties would also tend to be more honest right from the pre-contract period. The fact that this is not the case shows that the law bestows upon the already dishonest parties the duty to prove their honesty to each other. This is indeed different from a situation where the insured is compelled to provide information under the disguise of acting in good faith. And yet it is not all available literature that appears to differ with the possible continuation of the doctrine of utmost good faith. Rodrigue notes that the doctrine has been very helpful in resolving complex disputes that are not elaborately covered by other pieces of law.35 Dixon noted that the duty of disclosure is not only applicable in the insurance sector but is also important across the entire legal framework.36 The explored literature indicates researchers agree that the doctrine of utmost good faith has lost touch with the evolution in other parts of law, with two axis of thought emerging based on how each group recommends dealing with the problem. One group recommends modernisation of the same law, implying minimal changes, while the other calls for a complete removal or replacement of the doctrine. Conclusion The marine insurance sub-sector has one of the strongest attachments to the doctrine of utmost good faith. The essay explored the place of the doctrine in the face of fast-evolving insurance scenarios that, like any other sector of the economy, have forced an overhaul of the law in compliance with the trending changes. But unlike the other sectors that have already undergone massive legal revaluation, the marine insurance sub-sector has held on to a relatively old legal framework. The present essay sought to provide a firm background to the doctrine, highlight its applicability within the sub-sector and elaborate on its position as a continuing legal basis for making legal decisions. The position of the doctrine in both contract and insurance laws was evaluated with a view of comparing and contrasting its applicability across the two scenarios. The stages of the contract process were highlighted and details of how the doctrine contributes to the relationship between the insured and the insurer at each explored. The views of scholars and ‘insurance insiders’ were also examined towards the end of the essay, providing a glimpse into the diverse views presented by scholars from different schools of thought. The overall position is one of low confidence in the doctrine as a progressive tool to accommodate further growth of the insurance sector. The doctrine appears as a bedrock of inflexibility and should be phased out to allow for more accommodating legal provisions. The fact that the doctrine has been exploited by insurers intent on backtracking on their legal mandate to compensate insureds for legally-sound claims presents the height of intolerable mischief that the doctrine has bred. In its present form, the doctrine of utmost good faith is a weak link in the law of insurance that needs urgent review and possible repeal. The most recent attempt to amend this doctrine through the Consumer Insurance (Disclosure and Representations) Act of 2012 has not been very successful either, despite the obvious greater recognition given to the previously side-lined insured individuals. The Act gives the consumers greater control over the whole process than they previously had. However, it does not appear to seal the costly loopholes that have enabled insurers to avoid the duty of paying up monies that are based on genuine claims; where the insured did not make fraudulent misrepresentation or breached warranty terms after initiation of the contract. Bibliography Alistair Maughan and Sarah Wells, Client alert: Good faith obligations in English law (Morrison & Foerster LLP 2013). Assunta Di Lorenzo, The duty of utmost good faith (International Bar Association 2014). Christopher Butcher, ‘Good faith in insurance law: A redundant concept?’ 2008 (5) Journal of Law and the Biosciences: Oxford Journals 377. Herbert Smith, Ten key points to remember about insurance (Gleiss Lutz and Stibbe 2014). Howard Bennett, ‘The Maritime Insurance Act 1906: Reflections on a centenary’ 2006 18 Singapore Academy of Law Journal 670. J Edward Bailey, A doctrine of good faith in New Zealand contractual relationships (University of Canterbury 2009). Jan Woloniecki, ‘The duty of utmost good faith in insurance law: Where is it in the 21st Century?’ 2002 69(1) Defence Counsel Journal 4. Jean-Paul Rodrigue, The geography of transport systems: Transportation, globalization and international trade (3rd Edition) (Routledge 2013). John Lowry, ‘Whither the duty of good faith in UK insurance contracts’ 2011 16(1) Connecticut Insurance Law Journal 99. Julian Burling, Julian M Burling and Kevin Lazarus, Research handbook on international insurance law and regulation (Edward Elgar Publishing, 2011). Majed O Bamarouf, How could the doctrine of utmost good faith affect intermediaries and mortgages in marine insurance contracts? (University of Birmingham 2011). Marko Pavliha, Overview of marine insurance law (IMO International Maritime Law Institute 2010). MD Chalmers and EH Hardy Ivany, Chalmer’s Marine Insurance Act 1906 (LexisNexis UK 1993). Reason Global, Brief explanation of the Marine Cargo Act 1906 (Marine-Global 2006). Rebekah Dixon, A leap of good faith: A possible response to unfair claims-handling practices in insurance (University of Otago 2012). Robert Merkin, A report for the English and the Scottish law commissions on the Australian experience of insurance (English and Scottish Law Commission 2008). Rupert Cohen, ‘Good faith in insurance law: A redundant concept’ 2013 (1) The Student Journal of Law 2. Shaan Burton, Reform of Section 53 of the Marine Insurance Act 1906 – Should the broker be liable for payment of the premium? (2014 http://www.waltonsandmorse.com/reform-of-section-53-of-the-marine-insurance-act-1906-should-the-broker-be-liable-for-payment-of-the-premium/). Shannon Kathleen O’Byrne, ‘The implied term of good faith and fair dealing: Recent developments’ 2007 8(2) The Canadian Bar Review 195. Shi Feng, ‘Utmost good faith in marine insurance: A comparative study of English and Chinese maritime law’ 2008 (1) Plymouth Law Review 156. Susan Hodges. Cases and materials on marine insurance law (Routledge 2012). The National Archives, Consumer Insurance (Disclosure and Representations) Act 2012 (The Stationery Office 2012). Ulrich Magnus, ‘The remedy of avoidance of contract under CISG – General remarks and special cases’ 2006 25 Journal of Law and Commerce 425. Which? Consumer Rights, Regulation: Misrepresentation Act 1967 (2015 http://www.which.co.uk/consumer-rights/regulation/misrepresentation-act-1967). William Michael Dixon, An examination of the common law obligation of good faith in the performance and enforcement of commercial contracts in Australia (Queensland University of Technology 2005). William Tetley, ‘Good faith in contract: Particularly in the contracts of arbitration’ 35(4) Journal of Maritime Law & Commerce 578. Yu Zheng, The pre-contract utmost good faith in the insurance law – A comparative study of the Chinese law and the Common Law (National University of Singapore 2004). Read More