UK Court of Appeal confirms the legality of basis clauses

In Genesis Housing Association Limited v Liberty Syndicate Management Limited and others [2013] EWCA Civ 1173 the Court of Appeal upheld the first instance decision of Mr Justice Akenhead and confirmed the legality of basis clauses. A basis clause is a provision set out in the proposal form or in the insurance contract itself, to the effect that all or any of the answers to the questions in the proposal shall form the basis of the contract of insurance. By virtue of a 'basis clause' the insured warrants the truth of the answers set out in the proposal. Should any of those answers – whether material to the risk or not – prove to be untrue, the insurer may repudiate the policy and treat itself as never having been on risk. As the builder who was to undertake the development was incorrectly stated in the proposal form, Genesis could not recover under the policy because it was in breach of warranty.

This decision is likely to be followed by the Hong Kong courts if a dispute in relation to a 'basis of contract' clause was to arise. In England, whilst the Law Commission has proposed to abolish the use of basis clauses for business insurance contracts, any changes to the law are likely to take several years.

Background

Liberty Syndicate Management Limited (for and on behalf of Lloyd's Syndicate 4472) ("insurers") underwrote policies known as Premier Guarantees for Social Housing (the "Policy"), which were administered by MD Insurance Services Ltd ("MD"). The Policy provided cover for latent defects in social housing.

In 2007, Genesis Housing Association Limited ("Genesis") acquired the leasehold to a large number of flats, as part of a renovation and redevelopment project in Bedford. Genesis contracted with Time and Tide (Bedford) Ltd ("TT Bedford") to carry out the renovation of the leased properties. A term of the contract between Genesis and TT Bedford obliged TT Bedford to secure a building guarantee for the benefit of Genesis and the future owners of the properties.

The owners of TT Bedford, Graham and Perry Gamby, approached MD, seeking a policy. The policy was to include an endorsement providing an indemnity in the event of TT Bedford's insolvency during the build period.

The proposal form was completed by an MD employee and signed by Graham Gamby for and on behalf of Genesis (as agent) and TT Bedford. Time and Tide Construction Ltd ("TT Construction") was incorrectly named as the builder on the proposal form, the correct name of the builder being TT Bedford. The proposal form contained a declaration which included a basis clause and provided as follows:

"Declaration by the Insured

I/we declare that to the best of my/our knowledge and belief, the information I/we have given is correct and complete in every detail and I/we have not withheld any material fact.

I/we understand that the signing of this form does not bind us to effecting insurance under the Premier Guarantee for Social Housing scheme but agree that should a contract be completed for a New Development or Housing Unit that this proposal and the statements made therein shall form the basis of the contract between me/us and the Insurer." [emphasis added]

In 2010, following severe delays on the build, TT Bedford was dissolved. Genesis sought to enforce the insolvency provision in the Policy without success, and consequently, proceedings were issued against insurers.

First instance decision

We commented on the first instance decision of Mr Justice Akenhead in our Annual Review 2012. In short, Mr Justice Akenhead confirmed that basis clauses continue to be legal and will be enforced by the courts. While provisions contained in a policy could negate the effect of a basis clause contained in a proposal form, the wording included in the Policy was not sufficient to negate the effect of the basis clause.

Genesis appealed the decision to the Court of Appeal.

Decision of the Court of Appeal

The Court of Appeal unanimously dismissed the appeal. In reaching their decision, they considered three main issues which we consider in turn below.

1. Did the statements in the proposal form become contractual warranties?

Lord Justice Jackson (who gave the leading judgment) reviewed the leading authorities on the effect of a basis clause: "The principle which emerges from these authorities is that where a proposal form contains a "basis of contract" clause, (i) the proposal form has contractual effect even if the policy contains no reference to the proposal form; (ii) all statements in the proposal form constitute warranties on which the insurance contract is based".

He held that the principle was not open to challenge in the Court of Appeal but could be displaced by express words in the insurance policy. However, the fact that the policy set out a comprehensive list of all the documents said to comprise the policy and omitted the proposal form was not sufficient to displace the principle here: "If the parties intend to deprive of contractual effect a proposal form which purports to be the basis of their contract, they must do so by clear and unequivocal language. The policy in the present case contains no such express words".

Thus the proposal form was of contractual effect and the statements in the proposal form became warranties forming the basis of the policy.

2. Did Genesis warrant that TT Construction was to be the builder?

The name of the builder in the proposal form was stated as TT Construction. It was submitted by Genesis that the declaration in the proposal form qualified the statements made in the body of the proposal form; in the first sentence of the declaration the proposer declares not that those statements are true but that they are true to the best of his knowledge and belief. As Mr Justice Akenhead had found the error in the proposal form to be inadvertent, it was submitted that there was no breach of warranty.

This argument was dismissed for a number of reasons. Factually, it had no basis as both Mr Galliers of Genesis and Mr Gamby knew that TT Construction would not be the builder and, therefore, the statement in the proposal form was contrary to what was known to be the case. In addition, Lord Justice Jackson said that the two sentences of the declaration were independent of each other and the first sentence did not qualify the basis clause in the second sentence: "The "basis of contract" clause cannot be read down, so as to mean that a misstatement has no effect if the proposer is unaware of the error".

3. Did condition 7 restrict the insurers' right to avoid for misstatement to circumstances where there was intent to defraud?

Condition 7 of the Policy provided:

"Misrepresentation

This Policy will be voidable in the event of misrepresentation, misdescription, error, omission or non-disclosure by the Policyholder with intention to defraud".

It was contended by Genesis that the effect of condition 7 of the Policy was to limit insurers' right of avoidance to cases where the policyholder intended to defraud. Lord Justice Jackson dismissed this argument on the basis that it was not expressed to be a limiting provision and if the parties intended to achieve such an unusual result, they should (and would) have said so expressly: "In my view condition 7 of the Policy can only be read as a provision conferring additional express rights on the insurers, regardless of whether or not those express rights serve any useful purpose. It cannot be read as cutting down the insurers' general right to avoid for misrepresentation".

Comment

It has long been settled law, both in England and Hong Kong, that answers provided to questions in a proposal or an application form (with a declaration signed by the insured) are incorporated into the insurance policy (although not set out in the policy).  Any incorrect answer is usually fatal to the insured's claim irrespective of whether the question was answered in good faith to the best of the insured's knowledge, or, whether the response related to a material fact.

Whilst the English and Scottish Law Commissions, as part of their review of insurance contract law, propose to abolish the use of basis clauses for business insurance contracts, any changes to the law are likely to take several years; their final report and draft bill are expected in December 2013 but any reforms are unlikely to be enacted until 2015 to 2016.

Meanwhile in Hong Kong, there are no proposed changes to the law relating to 'basis of contract' clauses.  The Court of Appeal's decision in Genesis Housing Association Limited v Liberty Syndicate Management Limited and others [2013] EWCA Civ 1173, therefore, is likely to be followed by the Hong Kong Courts in the future.

Buyers of insurance policies are advised to liaise with their brokers and insurers to discuss removing any basis clauses at the earliest opportunity or ensuring that other provisions within the policy render the basis clause of no effect.

Airmic (the trade association representing more than 1,000 professional risk managers and insurance buyers), with assistance from Herbert Smith Freehills LLP, published a guide in 2013 to raise awareness of basis clauses and a sample endorsement to disapply them. A number of leading insurers have been supportive of the approach set out in the guide.

The guide and sample endorsement (which can be applied mid-term) can be found on Airmic's website at http://www.airmic.com/research/guides/basis-clauses.

Please speak to Paul Lewis (London) or Gareth Thomas (Hong Kong) if you wish to discuss.