Good Faith and Insurance Contracts

Peter MacDonald Eggers and Sir Simon Picken

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CHAPTER 13 Third parties

13.01 The courts classically have examined the duties of good faith within the surrounds of the bilateral relationship between an assured and an insurer. The principal questions thrown up in such cases are whether good faith dictates that the one party owes a duty of some sort to the other party and whether the duty found to exist has in some way been contravened. The scrutiny paid to this enquiry rightly has led to an involved and evolved exposition of uberrima fides as between assured and insurer. 13.02 It would be short-sighted, however, to confine one’s consideration of the duty of good faith to this two-way street. There will also be the occasional intersection, slip-road and roundabout in that the duty may affect the position of a third party, who himself is not a party to the insurance contract. The obvious third party, without whom the insurance world would be much deprived, is the insurance broker. The broker is a person who brings the assured and insurer together and brings about the contract of insurance. Given this pivotal role, the common law developed unique duties attaching to the broker, even though he is a stranger to the contract. There are, however, other third parties who may influence or be influenced by the insurance contract, such as other agents, co-insurers, assignees, and co-assureds. This chapter will look at the position of these third parties. 13.03 Before embarking upon these slip-roads, some general comments should be made. The duty of good faith is owed by each party to the contract of insurance and by the agents of each of these parties. There are other persons who become involved in this relationship willingly or without their wish or knowledge. The parties to the insurance contract will not owe a duty of good faith to any third party, except an assignee of the entire contract,1 even though that third party may be entitled to enforce certain terms of the insurance contract pursuant to the Contracts (Rights of Third Parties) Act 1999.2 Such strangers, except brokers, do not owe any greater duties to the contracting parties than those to which they are subject at law.3 Therefore, a third party, such as a life to be insured, a loss payee, beneficiary or a referee, will owe no duty of disclosure to the insurer, and so any material non-disclosure by that third party will not alter the position of the assured, unless the policy provides otherwise.4 Such third parties may be liable in negligence or fraud if their

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representations are false and induce the insurer to enter into the insurance contract with the assured.5 However, the third party’s representation or lack of disclosure will not affect or bind the assured, unless they are or act as agents for the assured.6 It is possible that the assured may use a third party, even another insurer, to influence the judgement of the contracting insurer to enter into a contract,7 in which case the assured’s actions or failings will be considered in light of his obligation of good faith. Where the assured is aware that the insurer has been the recipient of a misrepresentation or misinformation as to a material matter, then the assured should take it upon himself to correct any misunderstanding.8 In Pilmore v Hood,9 the vendor of a business informed a potential purchaser, one Bowmer, that the business’s income was at a certain level, whereas in fact the takings of the business were substantially less. With the knowledge of the vendor, Bowmer passed this information on to the plaintiff, who ultimately agreed to purchase the business. The court held that this fraudulent representation was actionable at the suit of the plaintiff. Indeed, in the earlier case of Hill v Gray,10 it was held that a contracting party may avoid the contract if he suffers under a delusion materially affecting that contract, where the other party is aware of the delusion and its falsity. This decision has been disapproved, albeit not overruled, in the context of ordinary contracts.11 As regards insurance contracts, such a decision would not be surprising as any falsehood to which the insurer has fallen prey to the knowledge of the assured should oblige the assured to rectify the delusion, consistently with the assured’s duty of the utmost good faith. 13.04 Further, the material that must be provided to the insurer will often be thrust upon the assured by the actions of another party with whom the assured had been negotiating. In this way, the duty of the assured may be influenced or prompted by a third party. For example, where a possible insurer refuses to insure a risk, the assured may have to disclose this fact to the contracting insurer, depending upon the custom of the relevant market.12 Similarly, where an insurer obtains from his assured information pertinent to the risk that

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he intends to reinsure or has reinsured, he may be obliged to pass that information to his reinsurer.13 Furthermore, the assured will have imputed to him the knowledge of his agents, which he generally will be obliged to pass on to his insurer.14 13.05 If it is alleged or proved that the assured has acted or omitted to act in breach of good faith, that may pose consequences for him in his relations with third parties. Where an assured has failed to make a material disclosure to his insurer, that breach may itself render him in breach of contract as regards another party who has relied on the validity of the policy, such as a CIF buyer,15 or may prejudice the policy that he assigned to a third party.16 13.06 As a final prefatory remark, the character of the insurance policy is such that it may encompass the contracts of many parties, whether they be co-assureds or co-insurers. One policy may signify many tens of contracts. The effect of the duty of the utmost good faith or its breach on one of those contracts may be felt as a tremor throughout the other contracts embodied by the policy.17

Assignees

Assignee or co-assured?

13.07 When the court is faced with the argument that an assignee cannot succeed in his claim under the policy, the court must first determine whether the claimant may properly be labelled an assignee or whether it is more accurate to look upon the claimant as a co-assured.18 Often, the assignee will have an interest in the subject-matter of the insurance that is different to that of the original assured. For example, the owner of a ship may insure the vessel and either may include in the same policy the interest of the mortgagee who has advanced funds to the owner for the purposes of the vessel’s purchase or subsequently assign the policy to the mortgagee. If the former, the mortgagee will be a co-assured and therefore a party to the contract.19 If the latter, the mortgagee will be an assignee. This is a question of fact. In Bank of New South Wales v South British Insurance Co Ltd,20 the plaintiffs claimed under a cargo policy insuring copper ingot bars which had been shipped from New South Wales to Germany. The consignees who had effected the insurance were German nationals and upon the outbreak of the 1914–1918 war became “alien enemies” with the consequence that the policy in so far as it insured the consignees’ interest was void. The

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plaintiffs, however, were Australian and claimed that the policy also insured their interests as pledgees. The Court of Appeal held that if the German assured had placed the insurance on their own behalf and on behalf of the plaintiffs, then the insurance of the pledgees’ interest was not void; however, if the policy had been assigned to the plaintiffs, their interest or title was derivative and they could occupy no more advantageous position than that of the assignor. In this case, the court held that the plaintiffs were assignees only, because when the insurance was placed, the plaintiffs had no interest in the property insured.21 The touchstone lies within the parties’ contemplation: if the party in question was intended to be a co-assured or assignee, then the parties’ intention should be heeded.22

The assignment is subject to equities

13.08 The rights that exist by virtue of an insurance policy essentially are rights of action (or choses in action). Choses in action were not assignable at common law, but assignments of choses in action were recognised as valid in equity subject to prior equities.23 Accordingly, if the assignee of a policy from an assured wished to pursue an action against the insurer, the assignor would have to bring an action at law against the insurer as trustee for the assignee and accordingly account to the assignee.24 However, the courts do now recognise an equitable assignee’s title to sue, although there is a rule of practice that the assignor (who retains the legal title) should be joined if there is a risk that the assignor might bring his or her own claim.25 The Policies of Assurance Act 1867 allowed life insurance policies to be fully assignable, the Policies of Marine Assurance Act 186826 allowed the assignment of marine policies and the Law of Property Act 1925 (section 136) extended the same courtesy to all policies. The assignment of marine policies is now permitted by section 50 of the Marine Insurance Act 1906. Insurance policies are often assigned as security for a debt owed by the assured to the assignee or because of the sale of the subject-matter insured. Accordingly, mortgagees, pledgees, chargees and purchasers of the property insured may become assignees of an insurance policy. There may, of course, be other circumstances that give rise to an assignment of a policy. 13.09 Section 50(1) of the Marine Insurance Act 1906 regulates the assignment of marine policies and provides that a marine insurance policy is assignable before or after the occurrence of a loss that is indemnifiable under the policy.27 The assured’s interest in a marine policy may be assigned without the express consent of the insurer, unless the policy itself expressly (not impliedly) provides that an assignment is not permitted or not

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permitted without consent.28 Section 50 allows the assignee to bring an action on the policy against the insurer in his own name,29 provided that the whole of the assured’s beneficial interest in the policy is assigned.30 By section 50(2), in an action by the assignee, the defendant is entitled to “make any defence arising out of the contract which he would have been entitled to make if the action had been brought in the name of the person by or on behalf of whom the policy was effected”.31 13.10 Rights arising under all policies, marine and non-marine, may be assigned under section 136(1) of the Law of Property Act 1925.32 By section 136, the chose in action under a policy (namely, the right to claim under the policy or the right to premium) may be assigned – “subject to equities having priority over the right of the assignee” – in writing, provided that written notice is given to the debtor. 13.11 When a right of action under the policy is assigned, the assignee will receive that right subject to the equities and defects33 that attached to the right when it was vested in the assignor. Therefore, if the assignor’s right under an insurance policy is defective for the lack of an insurable interest in the property or interest insured or breach of warranty, the assignee will take no better or more effective right, as the assignee’s title draws its validity from the assignor’s interest. This is equally so where there has been a breach of the duty of the utmost good faith, whether it be a material non-disclosure or misrepresentation34 or the making of a fraudulent claim by the assignor.35 13.12 This position is confirmed by section 136 of the Law of Property Act 1925, but appears to have been qualified as regards marine policies by section 50(2) of the Marine Insurance Act 1906, which allows the debtor, in most cases the insurer, to raise any defence “arising out of the contract” against any action brought by the assignee that may have been raised had the action been brought by the assignor. It may be questioned whether this provision prevents the insurer from establishing any defence against the assignee, which he could have raised against the assignor, if the defence does not arise “out of the contract”. This phrase was not included in the predecessor to section 50, namely section 1 of the Policies of Marine Assurance Act 1868, which is identical to section 50(2) but for the

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words “arising out of the contract”. The 1868 Act was repealed by the 1906 Act. However, section 50 was expressed in the manner adopted in Pellas v Neptune Marine Insurance36 in construing the 1868 Act, where the court added as a constructive gloss to the statute the words “arising out of the contract”. Accordingly, there is or should be no difference between the two statutory incarnations. 13.13 The import of the phrase “any defence arising out of the contract” was put to the test in the context of the duty of good faith in William Pickersgill & Sons Ltd v London and Provincial Marine and General Insurance Co Ltd.37 In this case, a time policy was executed by the defendant underwriters over a vessel that was assigned to the plaintiffs as security for debts owed by the shipowners pursuant to a shipbuilding contract agreed between the plaintiffs and the owners. When the insurance contract was agreed, the owners failed to disclose to the defendants the fact that they had taken out an excessively overvalued disbursements policy. The defendants sought to avoid the contract on the grounds of the owners’ (the assignors’) material non-disclosure. Hamilton J held that the defendants could rely upon the owners’ breach of the duty of good faith against the assignees’ claim because section 50(2) applied and because the duty of disclosure, being an implied contractual duty, arose “out of the contract”.38 As has been discussed,39 the duty of good faith as applied to insurance contracts is now recognised to exist as a principle of the common law and not as an implied term or condition of the contract. Can the judicial shift in opinion concerning the status of the duty have any effect upon the application of section 50(2) to allegations of a want of good faith against an assignee? It is unlikely: first, the words “arising out of the contract” are wide in their scope and not limited to any reference to defences based on the terms of the contract, but extend to defences that arise as an incident or consequence of the contract;40 secondly, even if the section did not apply, as a matter of principle the assignee should not be placed in any better position than the position of the assignor, because the subject-matter of the assignment is an interest in a voidable contract so that if any defence is predicated on the nature and extent of the assigned interest, that defence should be available against the claim of the assignee just as much as that of the assignor.41 13.14 Additionally, the plaintiff assignees argued that avoidance would impose an unnecessary hardship upon them if the policy could be assigned only subject to the same defects that existed when the policy was in the hands of the assignor; the assignees said that a marine insurance policy should be able to be assigned to a purchaser for value without notice of the policy’s voidability in the same way as certain negotiable instruments may be so assigned.42 The court held that there was no principle or mercantile practice to place insurance policies in the same category as such negotiable instruments. The hardship

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argument was rejected, because its acceptance “would involve upsetting the business of insurance and inflicting unwarrantable hardship upon underwriters”.43 13.15 Sections 50(2) and 136 effectively provide no greater or lesser scope of defence to a claim by an assignee than was the position at common law: as the assignee’s claim had to be brought by the assignor as trustee for the assignee, the defendant could defeat the claim by relying upon the assignor’s breach of duty. This derivative nature of the assignee’s interest in the chose in action assigned is recognised by the fact that his interest is subject by statute to “any defence arising out of the contract” or “equities having priority”.44 13.16 The insurer can rely upon the assured’s original failure to observe good faith in avoiding a contract that has been transferred to an assignee, if the statutory requirements are satisfied. In other cases, where there has not been an effective legal or statutory assignment, the assured may have to bring any claim against the insurer as trustee for the assignee or the assignee may be able to sue in his own name; in such actions, the insurer can of course rely upon the assured’s transgression of good faith to defeat any claim that may belong beneficially to the assignee. The assignment of the chose of action in such cases, which is recognised in equity, must of course defer to the defects in merits of the assignor’s cause of action. 13.17 Similarly, if the insurer violates the duty of utmost good faith and subsequently assigns the policy to another insurer, the assured will be able to rely upon such a breach of duty as against the assignee. There have been almost no cases on the effect of a breach of duty on an assignee insurer. The matter, however, was touched upon in Banque Financière de la Cité v Westgate Insurance Co Ltd (sub nom Banque Keyser Ullman SA v Skandia (UK) Insurance Co Ltd).45

When must the equities exist?

13.18 In cases where there is an assignment of a chose in action arising in respect of the policy, valid only in equity, the assignor’s breach of duty will plague the assignee’s interest both before and after the assignment, as the law recognises only or principally the assignor’s title. Similarly, where there is an assignment of a chose of action under the Law of Property Act 1925, any breach of the duty of good faith by the assignor after the assignment will affect the assignee, even though the chose in action assigned is wholly assigned.46 While the assignor retains any interest in the insurance contract, as the contracting party, the assignor’s breach of duty will pose consequences for the assignee. When only a chose in action in the contract has been assigned, the duty, however, is a duty that is owed mutually between the original contracting parties.47 However, where the entire contract is assigned, the assignor will cease to bear a duty of utmost good faith so that the

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assignor’s conduct after that date becomes irrelevant to the assignee’s right of recovery under the policy.48 13.19 A question arises whether the insurer may establish a defence of the breach of the duty of good faith against the claim of the assignee if the breach of duty occurs after the insured loss. The argument states that the assignee’s right against the insurer exists or is vested in the assignee when the loss occurs and that any breach of duty that occurs afterwards, say in the assured’s presentation of a claim, can have no effect upon the assignee. Such an argument is misguided because the assignee’s interest is merely the interest in the contract of insurance and if the assignor acts so as to render the contract voidable, the insurer should be able in principle to avoid the contract against the assignee.49 13.20 While the assignor’s breach may destroy the value of the right assigned, this does not mean that the assignee will become liable for the assignor’s breach. In Banque Financière de la Cité v Westgate Insurance Co Ltd (sub nom Banque Keyser Ullman SA v Skandia (UK) Insurance Co Ltd),50 on 1 October 1980, the underwriter (Mr Dungate), who was treated at first instance as being in breach of the duty of good faith, ceased employment with one insurer (Hodge) and obtained a position with another insurer (Skandia). Steyn J (as he then was) found that Mr Dungate had been in breach of the duty of good faith in respect of insurance he underwrote both before and after 1 October 1980.51 Together with this change of employment, rights and obligations under the policy underwritten by Mr Dungate on behalf of Hodge were assigned to Skandia. A further insurance contract was agreed by Mr Dungate on behalf of Skandia after 1 October 1980. On the facts of this case, the learned judge held that Hodge’s vicarious liability for the breach of duty of Mr Dungate was not transferred by the assignment to Skandia. At first sight, one may wonder whether the judge’s statement is in fact correct. However, on closer scrutiny, it must be treated as justified. The assignment of the policy will operate to transfer to an assignee the assignor’s interest in the policy; if the interest is defective or subject to equities, then only a defective interest will pass. Accordingly, if the contract could be avoided by the assured, who then seeks restitution of the premiums he has paid, the assignee must accept that the contract will be avoided; however, he will not be liable to effect restitution, because he has nothing to restore to the assured, unless by the assignment he has accepted such liability. In the present case, it appears that such liability was not assigned. Therefore, Hodge retained any liability for breach of the duty of utmost good faith perpetrated by Mr Dungate before he terminated his employment with them, even after the policy was assigned.52

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When will the assignee be subject to the duty of the utmost good faith?

13.21 The duty of good faith is owed as between the original parties to the insurance contract, the assured and insurer. The position will be different when the assured or insurer assigns all of his rights and obligations in the contract to a third party, so that the assignee becomes a party to the contract in his own right. In such a case, if the assured has assigned the policy completely, the insurer will owe a duty of good faith to the assignee, and not the assignor, in respect of the policy that has been assigned. The matter arose for consideration in Bank of Nova Scotia v Hellenic Mutual War Risks Association (Bermuda) Ltd; The Good Luck.53 The issue at hand was whether the club insurer was obliged to disclose to the plaintiff bank, an assignee of the subject policy, the fact that the insurance had ceased because of a breach of warranty that occurred after inception. The obligation of disclosure was alleged to have existed by reason of the policy and independently by reason of a letter of undertaking given by the club to the plaintiff bank. The letter of undertaking recorded the assignment as follows:

“It is noted that by assignment in writing ... the shipowners ... have assigned to The Bank of Nova Scotia in their capacity as first preferred mortgagees all the ship owners’ interest in this policy with all benefits thereof including all claims of whatsoever nature hereunder.”54

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