Supreme Court rules that a "collateral lie" is immaterial to the insurance claim

In Versloot Dredging BV and another v HDI Gerling Industrie Versicherung AG and Others [2016] UKSC 45, the Supreme Court held that policyholders who advance otherwise valid insurance claims by lies which are irrelevant to their rights to recover do not forfeit their claims under the policy: "the lie is dishonest but the claim is not". In doing so, the Supreme Court overruled the decision of the Court of Appeal ([2015] QB 608), and rejected the analysis of the law by Mance LJ (as he then was) in Agapitos v Agnew (The Aegeon) [2003] QB 556 ("The Aegeon") (on which the Court of Appeal decision had been based) that an insured who supports a valid claim with a lie forfeits his claim.

Background and judgment at first instance

The Appellants (the "Owners") were owners of the DC Merwestone, a cargo ship (the "Vessel"). The main engine was damaged beyond repair by the ingress of water into the engine room. The Owners claimed for the damage under their marine insurance policy (the "Policy") underwritten by the Respondents (the "Underwriters").
The Underwriters denied liability on a number of grounds, including on the bases that:

• the loss was not caused by an insured peril;
• the Owners were aware that the Vessel was unseaworthy when it was sent to sea and accordingly under section 39(5) of the Marine Insurance Act 1906 the Underwriters were not liable for loss attributable to the fact that the Vessel was unseaworthy at the commencement of the voyage; and
• the Owners forfeited their claim when one of the Vessel's managers lied about the circumstances of the water ingress.

Mr Justice Popplewell at first instance held that the loss was caused by an insured peril, namely the fortuitous entry of seawater through the sea inlet valve during the voyage, and the Owners were not aware that the Vessel was unseaworthy at the commencement of the voyage. The Policy excluded cover for losses caused by want of due diligence by the Owners but the judge held that, contrary to the Underwriters' arguments, the loss was not caused by want of due diligence of the Owners. The loss was therefore in principle covered under the Policy.

In advancing the Owners' claim, however, Mr Kornet, one of the managers of the Vessel, told the Underwriters that the Master and crew of the Vessel had claimed to have heard the bilge alarm begin sounding hours before water was seen under the floor plates but the crew had been unable to investigate or deal with the leak because of the rolling of the ship in heavy weather. This was a lie told to prevent it from appearing that the Owners had not exercised due diligence and to encourage Underwriters to grant an indemnity sooner.

Mr Justice Popplewell considered himself bound to hold that an insured who advances an otherwise wholly valid claim by fraudulent means or a fraudulent device forfeits the entire claim, although he considered the result disproportionate and reached this decision with some regret.

The judgment in the Court of Appeal

The Court of Appeal held that the judge had been entitled to find that the Owners were at least reckless as to whether Mr Kornet's explanation for the flooding was supported by the crew's recollection. Mr Kornet's untruth was directly related to and intended to promote the claim. The Court of Appeal applied Mance LJ's analysis of the law in The Aegeon on the following bases:

• whilst not binding, The Aegeon is authoritative;
• a fraudulent device is a sub-species of a fraudulent claim;
• there is a public policy justification for the rule that policyholders who advance fraudulent claims, or valid claims by fraudulent devices, forfeit their claims;
• the Law Commission proceeded on the basis that fraudulent devices fall within the fraudulent claims doctrine;
• case law provided some support for the application of the fraudulent claim rule to fraudulent devices; and
• The Aegeon was cited without disapproval in a number of subsequent cases and academic authorities.

For more information on the decision in the Court of Appeal in this case, see our e-bulletin, which you can download here.

The Supreme Court judgment

The Supreme Court, by a majority of four to one (Lord Mance dissenting) allowed the Owners' appeal and accordingly judgment was entered in favour of the Owners.
Lord Sumption, with whom Lord Clarke, Lord Hughes and Lord Toulson agreed, delivered the leading judgment.

(1) The fraudulent claims rule

Insurers are not liable at common law to pay fraudulent claims. "Fraudulent claims" include (1) claims which are wholly fabricated; and (2) legitimate claims which have been dishonestly exaggerated. In these situations, the insurer is not liable (even, in the second instance for the legitimate portion of the claim). The question before the Supreme Court was whether a justified claim supported by "dishonestly embellished" information is also forfeited. The rationale of the fraudulent claims rule is the deterrence of fraud. By providing that insureds who make fraudulent and fraudulently exaggerated claims forfeit any claim, the law protects insurers from a "one way bet" in which if the insured is caught, he loses nothing, and if he is not caught he stands to benefit.

(2) "Collateral lies", not "fraudulent devices"

Lord Sumption noted that such embellishments have been described as "fraudulent devices" but rejected this expression as "archaic" and failing to describe the problem. He adopted (as did Lords Clarke, Hughes, and Toulson) the expression "collateral lies", meaning lies which, when the facts are found, are not relevant to the insured's right to recover.

(3) Collateral lies distinguished from fraudulent and fraudulently exaggerated claims

An insured's right of indemnity arises as soon as he suffers loss. Lord Sumption distinguished between (a) fraudulently exaggerated and fraudulent claims; and (b) justified claims supported by collateral lies. In the former case, an insured seeks something to which he is not entitled. The law declines to sever the honest part of the claim from the invented part. In the case of the latter, Lord Sumption said "the lie is dishonest, but the claim is not". The immateriality of the lie makes it "not just possible but appropriate to distinguish between them".

If the fraudulent claims rule applied to valid claims supported by collateral lies, however, insurers would be protected from their "obligation to pay an indemnity for which they have been liable in law ever since the loss was suffered". This suggested that the fraudulent claims rule should not be applied to valid claims supported by collateral lies.

(4) The anomaly of no requirement of inducement

Lord Sumption considered the fact that an insured might forfeit his claim by telling a collateral lie, irrespective of whether the insurer relied on that lie, an anomalous result in civil law. Claims in deceit, for rescission of a contract for misrepresentation, and indeed to avoid an insurance contract for material misrepresentation or non-disclosure all require that the claimant establish that the defendant's misrepresentation or lie induced it to act upon it. If an insured forfeited an otherwise valid claim by telling a collateral lie, irrespective of whether the insurer relied upon it, this would be anomalous.

(5) The materiality threshold

The Underwriters contended that the only connection between the collateral lie and the claim which was required for the fraudulent claims rule to bite was that the lie was material to the merits of the claim as they would have appeared to a hypothetical insurer at the time the lie was uttered. In The Aegeon, Mance LJ (as he then was) had tentatively suggested that a lie would be material if it led to a "not insignificant improvement" in the insured's prospects. Christopher Clarke LJ suggested in the Court of Appeal that the materiality threshold should be whether the lie led to a "significant improvement" and Lord Mance endorsed this proposal in his dissenting judgment.

Lord Sumption rejected this argument, which he noted was similar to the test for the materiality of pre-contractual misrepresentations and non-disclosures, for two reasons. First, given that inducement was irrelevant, "it was difficult to see" why materiality should be judged on the basis of the apparent merits of the claim at a particular time rather than the actual merits of the claim. Secondly, the insurer has discretion in deciding whether to accept a risk at the pre-contractual stage. In contrast, when deciding whether to accept a claim under an existing contract, the insurer's position is very different. The insurer has no discretion because he is already bound. The materiality of a lie must therefore be "based on its relevance to a court which is in a position to find the relevant facts". Thus the fraudulent claims rule applies to wholly fabricated claims and to exaggerated claims, but not to a lie which "the true facts, once admitted or ascertained, show to have been immaterial to the insured's right to recover".

(6) Telling collateral lies is not without risk

Lord Hughes added that there are a number of potential penalties which fall short of forfeiture for an insured who told a collateral lie in support of a valid claim:

• The insured who tells a collateral lie will have committed a criminal offence (although the risk of prosecution is relatively slight).
• The insured may be held liable in damages to insurers.
• An insured who tells a collateral lie is in practice likely to lose most or all of his credibility, in court and out, in a debate about his entitlement under the policy. Lord Toulson made the same point in his judgment, referring to the "Lucas direction" in criminal trials, which directs the jury that even if it appears a defendant has lied, he may nonetheless be innocent and seeking to bolster a just cause.
• If there is litigation, there are likely to be "expensive inter partes costs orders as a result of [the] fraud".
• Insurers are likely to terminate the policy, at least prospectively.
• The history will be a material fact to be disclosed in future insurance proposals and is likely to lead either to a refusal of cover or to higher premiums.

These are in addition to any express penalties in the policy.

Lord Hughes considered this result consistent with the evolution of the common law rule on fraudulent claims to exclude from its operation fraud committed after litigation begins. He also considered the result consistent with the Consumer Insurance (Disclosure and Representations) Act 2012 (which is in force) and with the Insurance Act 2015 (which is due to come into force in August), which leave open the definition of "fraudulent claims".

Lord Mance's dissenting judgment

Perhaps unsurprisingly, given his view in The Aegeon, Lord Mance dissented. Lord Mance argued that the assessment of risk and the settlement of claims depend on good faith and fair information, which are consensual processes. He considered that the materiality of a lie must be based on its relevance to:

• the underwriter's assessment of how a court would rule in a case; and
• the underwriter's decision whether to pay.

Lord Mance said he would reach the same conclusion now as he reached in The Aegeon for the same reasons, although he would require that a fraudulent device led to "a significant improvement of the insured's prospects" (as Christopher Clark LJ suggested in the Court of Appeal) before a claim was barred. He considered that the fraudulent devices rule serves an important role in encouraging integrity and deterring fraud in the claims process. In particular, the rule adds an additional protection against fabricated or exaggerated claims: the discovery of a fraudulent device formerly barred any claim at all. Lord Mance suggested that fraudsters could now try their luck with other devices or lies with "virtual impunity". This would distort the claims process. Lord Mance considered that the loss of a claim was not disproportionate, given the policy underlying the fraudulent claims rule, and in any event "a person who uses fraudulent devices in the context of an insurance relationship deserves no real sympathy".

The Owners' human rights arguments

The Owners had contended that the rule under which valid claims advanced by fraudulent devices are forfeited was a disproportionate interference with their property rights under the First Article of the First Protocol to the European Convention on Human Rights ("A1P1").

The Court of Appeal had rejected this argument and held that the aim of deterring fraud in insurance claims was legitimate and although admittedly "very harsh" the sanction of forfeiture was not disproportionate.

Given the majority judgment on the common law position, the Owners' arguments that the rule on forfeiture of claims advanced by a collateral lie was a disproportionate interference with their property rights under A1P1 did not arise in the Supreme Court. Lord Mance commented, obiter, that he considered the deprivation would be and was a proportionate means of pursuing the legitimate aim of deterring fraud.

Comment

The Supreme Court ruling represents a significant change in the law on "fraudulent devices" (or "collateral lies") used to support legitimate claims. It is clearly a favourable development from the perspective of policyholders, who will not now stand to forfeit otherwise legitimate insurance claims for telling an irrelevant lie told at some point in the claims process.

The Insurance Act 2015, which comes into force on 12 August 2016, will not alter the position. Although section 12 of the 2015 Act, which applies to consumers and non-consumers, sets out remedies for fraudulent claims the 2015 Act does not define "fraud" or "fraudulent claims" which will fall to be determined in accordance with common law principles.

Lord Mance's concerns, which have been reiterated by the Association of British Insurers which described the Supreme Court ruling as "a blow for honest customers", are understandable. Nonetheless the significance of the ruling should not be overstated.

• Fabricated and exaggerated insurance claims will continue to be forfeited in their entirety. For example, the policyholder with a household contents policy claims for the theft of his television. If the policyholder's television was stolen but he submitted a forged receipt for the actual value of the television, he would now be entitled to an indemnity. If, however, the forged receipt was for more than the value of the television, or his television had not been stolen, he would forfeit the entire claim.
• Insurers may wish to provide in policy wordings that policyholders forfeit claims which they seek to support with false statements irrespective of whether such statements are relevant to cover. As Lord Mance said in his dissenting judgment, "insurers will no doubt be advised about whatever may be the potential merits of making express in future whatever understanding they have, or action they may wish to take, regarding the effect of fraudulent devices".
• The risks of supporting legitimate claims with lies, in particular the risk of being unable to procure insurance in the future, may act as a deterrent.
• As Lord Toulson said, "I am sceptical about the idea that knowledge of this judgment will incentivise people with valid insurance claims to lie in support of their claims. Those who are honest will not [lie in support of their claims] because it would not be in their nature, while some who are dishonest may do so if they think that they will get away with it, despite the risk of it having a boomerang effect on whether the court believes anything that they say."