Insurance: genuine claim will not be forfeit where supported by 'collateral lie'

The Supreme Court has decided by a 4:1 majority that the use of fraudulent devices – or collateral lies as the court preferred to call them – in support of genuine claims will no longer result in the claim being forfeited.

Insurers should consider including express terms excluding cover where a claim is supported by collateral lies and warnings that claimants resorting to such lies face possible prosecution.

Scope of Decision

This Supreme Court decision applies only in the relatively infrequent cases where a claim is found to be genuine, but the supporting evidence is falsified. These are cases involving ‘a lie which turns out when the facts are found to have no relevance to the insured’s right to recover.’ Where the value of a claim is exaggerated, or part of a claim is genuine and part false, the position remains that the entire claim will be forfeit. The judges distinguished the present case, where the sum due to the insured was unaltered by the invented supporting evidence, from those where the effect of such false evidence, if accepted, would have been that the insured received more than the sum to which it was entitled. The difference may only become apparent with hindsight, once all the facts are established. If it becomes clear that insurers would have been liable to indemnify the insured for loss of the same amount whether or not the collateral lie was believed, the claim would not be forfeit. If, on the other hand, the lie, if believed, would have resulted in the insured receiving improved terms, then the entire claim will, as now, be forfeited.

Background

The owners of a vessel, the DC Merwestone, suffered a loss of Euro 3.241 million in January 2010, when its engine room was flooded. The flooding occurred as a result of a number of factors, including the negligence of the crew in failing to close a sea inlet valve and to drain the system after fire hoses had been used to clear ice from the hatches. Loss resulting from negligence by the crew was covered under the ship’s insurance policy. During the course of investigations, however, one of the vessel’s managers had resorted to a ‘reckless untruth’ by claiming that the crew had been unable to respond to a bilge alarm because of the rolling of the ship in heavy weather. The judge at first instance and the Court of Appeal held that the entire claim was lost as a result of this lie, even though the time of the sounding of the bilge alarm and the crew’s supposed response were irrelevant to the question of cover under the policy. That decision has now been reversed and the Euro 3.241 million claim has been allowed.

Reasoning

This is said to be the first time that the House of Lords or the Supreme Court has had the opportunity to resolve the question whether the fraudulent claims rule applies to justified claims supported by collateral lies.

The key distinction is whether the claim is, on the one hand, entirely falsified or exaggerated, in which case, as now confirmed in statute (section 12 Insurance Act 2015), the claim is forfeit on account of the dishonesty, or, on the other hand, a claim that is wholly genuine but dishonestly supported.

The Supreme Court has decided that in cases where ‘the lie is dishonest but the claim is not’, the sanction of forfeiture of the claim is a wholly disproportionate response. This is based on the fact that, unlike in a fraudulent claim, a collateral lie brings the insured nothing which he was not entitled to have anyway, whilst the insurer loses nothing if he meets a liability that he had anyway. The insured’s right to indemnity arises as soon as the loss is suffered. The insurer should not, therefore, be protected by the application of the fraudulent claims rule from the obligation to pay an indemnity for which he has been liable in law ever since the loss was suffered. According to Lord Sumption, giving the lead judgment, there is no other context in which the civil law avoids a transaction on account of a fraud which has no impact on its intended target.

Insurance is recognised as a special case, because of the typical information disparity between the insured and the insurer, but the judge stated that ultimately, even the law of insurance is concerned more with controlling the impact of a breach of good faith on the risk than with the punishment of misconduct.

Whilst confirming that the ‘moral character’ of the insured’s lie is not mitigated because the lie turned out to be unnecessary, and referring to the danger of encouraging an insured to believe he has a ‘one-way bet’ if he lies in support of a genuine claim, the court considered that ‘there are principled limits to the role which a claimant’s immorality can play in defeating his legitimate civil claims’.

Lord Clarke put the position simply: the question whether collateral lies told by the insured should entitle underwriters to refuse to discharge their liability under a contract is essentially a policy question. In his view, public policy does not require that the insurer should be able to avoid payment in these cases.

Lord Hughes stressed that a perception that a fraudulent claimant now has nothing to lose through his embellishment would not be accurate. The fraud will still constitute a criminal offence (although the risk of prosecution is low), the claimant’s credibility will suffer, costs sanctions may be imposed and future insurance premiums may be substantially increased.

Ultimately, though, the judges considered that they needed to be guided by their own sense of what is just and appropriate. As Lord Clarke said, the extension of forfeiture to a purely collateral lie is not justified – it is simply too large a sledgehammer for the nut involved.

Dissenting Judgment

Lord Mance, in his dissenting judgment, stressed the importance of deterrence to insurance fraud. He pointed out that the purpose of the collateral lie is invariably to obtain an illegitimate advantage in securing acceptance of the claim, earlier payment or better settlement terms. Where persisted with at trial, the aim is to mislead the court. The collateral lie distorts the claims process. It cannot be right that the validity of a claim depends on a judgment made with hindsight, sometimes years later, as to whether or not a lie was material to a claim.

Lord Mance considered it unlikely that the risk of an adverse costs order in court will deter the fraudulent insured from telling the lie at the time it is told, and that in any event a person who uses fraudulent devices in the context of an insurance relationship deserves no real sympathy. He considered the majority verdict in this case to be a ‘charter for untruth’.

Impact

There is no change to the position that where a fraudulent insured fabricates or fraudulently exaggerates a claim and uses a fraudulent device in support, the claim is forfeit. But where a genuine claim is supported by a lie that has no actual impact on the claim payment, this does not give insurers a right to forfeit the claim. This deferment is a real concern for the insurance industry which has for many years battled against fraudulent claimants.

Insurers may wish to include express clauses in all policies specifying that cover will be denied in the event that a fraudulent device is used to support an otherwise genuine claim (although such clauses may now be subject to challenge as being unreasonable). Policy documentation should also include warnings about the consequences of lying in support of a claim, whether genuine or not.

Further reading: Versloot Dredging BV v HDI Gerling Industrie Verischerung AG [2016] UKSC 45