Summary of the Law Commissions’ Issues Paper on warranties

The English and Scottish Law Commissions are currently working on a review of the law of insurance and last week produced their Issues Paper on warranties. Although the paper has not been subject to formal scrutiny by the Commissioners and does not yet represent fixed policy, the tentative proposals are far-reaching and may overturn a number of established principles of insurance law. If adopted by the passing of a planned bill in 2009/2010, these proposals will cause a significant impact to the insurance and reinsurance industry.

The Law Commissions Review of Insurance Law

The Law Commissions’ joint project has so far examined two key areas of insurance contract law: non-disclosure and breach of warranty.

The first Issues Paper on misrepresentation and non-disclosure was published in September 2006. They concluded that the law was biased in favour of insurers and tentatively proposed that although the duty of disclosure should continue to apply to business insurance contracts in general, the law should be changed to give the insured certain additional rights, but that the rules should in general not be mandatory.

This article focuses on the Issues Paper on warranties, as it relates to business insurance.

The findings in relation to the current law

The Law Commissions concluded that the current law relating to warranties was unfair, at best hard to understand and did not reflect the expectations of insureds, both in a business and consumer context. They maintain that the overlap between law and regulation is unclear and there is evidence that the law is unsatisfactory and needs to be changed.

The Commissions found that the Marine Insurance Act 1906 ("MIA") leads to unfair results in respect of warranties and allowed insurers to refuse to pay claims for acts or omissions: -

- that are immaterial to the risk or that are only relevant to other risks; or

- that have already been remedied by the insured.

The problems are exacerbated by the use of "Basis of the Contract" clauses ("BOC"), which convert answers in a proposal form to warranties.

The scope of the Paper

The current thinking of the Commissions is that the reforms should also apply to reinsurance and marine and aviation contracts, unless there are good reasons to the contrary.

The tentative proposals

1. Warranties as to past/existing facts

The Law Commissions recommend that BOC clauses are rendered ineffective. If warranties of past or existing facts are to be permitted at all, each statement warranted should be set out either in the policy, or in some document incorporated in to it. They differentiated between warranties as to past or existing fact as opposed to warranties about future conduct because a warranty of past or existing fact already takes effect as a representation. In a business context, they have invited views on which of two possible proposals to adopt. Either:

(a) Incorrect statements of past or existing fact should only amount to misrepresentations and not warranties (this would be mandatory i.e. it would not be possible to contract out of this provision); or

(b) Insurers would be permitted to include warranties of specific facts. If the fact proved inaccurate, the insurer could use this as a defence to a claim even if the insured was not at fault, subject to the requirements for future warranties (set out in more detail below). (These are that insured must be provided with a written statement of the term, and that the claim must be causally connected with the breach).

2. Warranties as to future conduct

The proposals are designed to bring warranties to the insured’s attention and to limit insurers’ right to reject claims where the breach of warranty has no connection to the loss that has arisen.

The Commissions recommend that a claim can only be refused because the insured has failed to comply with a contractual obligation, if it is set out in writing and included or referred to in the main contractual document. This can be contrasted with the current position which is that a policy may incorporate terms by reference to statements made in a proposal form and that warranties do not have to be drawn to the attention of the insured.

3. Causal connection

To protect insureds from unfair treatment and to prevent bringing the industry into disrepute, they tentatively propose that a "causal connection" test be implemented; all insureds would be protected against claims being denied for reasons unconnected with the loss and insureds should be entitled to be paid a claim if they can prove on the balance of probability that the event/circumstances constituting the breach of warranty did not contribute to the loss. If a breach contributes to only part of a loss, the insurer may not refuse to pay the part of loss unrelated to the breach. The onus would be on the insured to show that the breach did not contribute in any way to the loss.

They invite views as to whether:

(1) the causal connection rule should be mandatory in business insurance (i.e. it would not be possible to contract out of the provision).

(2) the protection should apply to any term that purports to exclude or limit liability for events or circumstances that are thought to increase the risk of a loss occurring. (Their tentative proposal is that it would be too formalistic to confine the causal connection test to warranties).

(3) the causal connection test should be subject to an exception where the insurance relates to one purpose, activity or place, and the loss arises from another purpose or activity or in another place. In these circumstances, they suggest that the claim should not be paid if the loss related to an activity which was so far outside the terms of the cover that a "reasonable insured" could not have expected the loss to be covered even if there is no connection between the loss and the breach.

For example, where an exclusion in a marine contract operated for a war risk area, such as the Gulf, if a ship enters the Gulf, this should not automatically discharge the insurer from liability. Instead, when the ship leaves the Gulf, cover should resume. However, if the ship is in the Gulf at the time of a loss, it is arguable that no claim should be paid, even if the loss was not related to a war risk and could have happened anywhere.

4 The Effect of a Breach of Warranty

The Commissions propose that a breach of warranty should no longer result in the insurer being automatically discharged from liability (i.e. the decision of the House of Lords in Bank of Nova Scotia v Hellenic Mutual War Risks ("The Good Luck") [1992] would be overturned).

Instead, they ask whether the reforms should provide that:

(1) a breach of warranty should give the insurer the right to repudiate the contract?

(2) the insurer should have a choice between repudiating the claim only, or the policy for the future, or both? (i.e. it would seem that they are considering the introduction of the innominate term in insurance contracts as recognised by Waller LJ in Alfred McAlpine Plc v BAI (Run-Off) Ltd [2000])

(3) where the insurer accepts the insured’s breach, the insured should cease to be liable for future premiums?

(4) an insurer who terminates a policy following the insured’s breach should normally provide a pro-rata refund of the outstanding premium, less any damages or administrative costs?

(5) the insurer should be obliged to give notice that the contract is being terminated? If so, what would constitute a reasonable time for an insured to make other arrangements?

The law of waiver would also be affected. Loss by waiver of the insurer's right to repudiate the contract would be determined in accordance with the general rules of contract.

5. An unfair terms approach?

Potentially a very wide-ranging proposal, the Commissions will consider this option only if it were really needed. They invite views on whether:

(1) Exclusions or clauses that define the risk in business insurance contracts written on the insurers’ standard terms should be subject to a test of fairness. (i.e. the concept of fairness contained in the Unfair Contract Terms Act 1977 would be extended to insurance contracts, which are currently excluded from its ambit).

(2) If so, should the protection apply to all businesses or only those defined as small?

Impact of the "tentative proposals"

The Commissions acknowledge that certain provisions in the MIA 1906 would have to be repealed, as they would be incompatible with the new proposals (e.g. s33 (3) in respect of the effect of a breach of warranty). "Life as we know it" would change considerably and much of the development of the law on warranties that has developed over the centuries would change. The law on waiver (as set out in HIH v Axa ) would also be transformed.

Invariably more claims will be paid by insurers and reinsurers, which would be likely to increase premiums.

What now?

The Law Commissions intend to hold informal seminars and invite short responses at this stage to promote discussion and to gain feedback from the industry. Formal responses will be expected in 2007 when the Consultation Paper is published.

CMS Cameron McKenna will be collating views in order to submit feedback to the Law Commissions. If you are interested in participating in this process, please either contact your client relationship partner or Liam O’Connell and Gabrielle Folliard.

To access the Issues Paper please click here