Peering behind the curtain: Shadow Directors and the duty of fair presentation

The decision in Tynefield Care Ltd v The New India Assurance Company [2024] provides useful guidance about the insured's duty of disclosure, both before and after the Insurance Act 2015.

The case concerned an insurance policy taken out by a group of companies which owned and ran care homes. Following a fire at one of the care homes, the insureds claimed under the policy.  However, the claim was declined and the defendant insurer sought to avoid the policy.

The Court found that the insurer was entitled to do so. The judge held that the insureds had failed over several years to disclose that one of the three individuals operating the business was a de facto and shadow director and had previously been director of a company placed into administration.  This failure amounted to breach of the duty of good faith in respect of the older policies (pursuant to the Marine Insurance Act 1906 (MIA 1906)) as well as a breach of the duty of fair presentation in respect of the more recent policies (pursuant to the Insurance Act 2015 (IA 2015)).

In his judgment, HHJ Rawlings considered the test for materiality, which was identical both pre- and post-IA 2015. He also confirmed that a test for a "qualifying breach" (which allows an insurer to avoid a policy under the IA 2015) is the same as the test for inducement under the common law.

Critically in this case, the insurer was able to demonstrate that the insureds' misrepresentation had induced it to continue providing cover over a number of years.  The insurer successfully established that its strict practice was to refuse or cancel cover for companies whose directors had an insolvency history. This allowed it to avoid the policy in full.

The decision also considers the law on waiver by an insurer of the duty to fair presentation, following Ristorante Limited T/A Bar Massimo v Zurich Insurance Plc [2021] EWHC 2538 (Ch).

BACKGROUND

The insureds were a group of seven companies who operated care homes. The first policy was taken out in 2013 and renewed each year thereafter. The policies taken out before 12 August 2016 were subject to duty of utmost good faith pursuant to the MIA 1906. The policies taken out after 12 August 2016 were subject to duty of fair presentation under the IA 2015 (12 August 2016 being the date on which IA 2015 came into force).

On 22 August 2019, a fire broke out at one of the insured's care homes. A claim was made under the policy.

The insurer refused cover and also sought to avoid the policy on the basis that the insureds had breached their respective duties of utmost good faith and fair presentation (as relevant to the policy in question). The insurer also argued that the insureds had misrepresented the true state of affairs in the original proposal form that was provided in 2013, when the policy was first incepted, and in subsequent renewals.

The allegations of breach centred on the role of one of the key individuals involved in operating the company, Mr Khosla, and his insolvency history.

In summary, each of the insured companies formally had two directors, but there were three individuals involved in operating the insured companies: Mr Khosla, Mrs Khosla and Mrs Ghai. There were certain periods between 2013 and 2017 during which Mr Khosla was not a de jure director, and was replaced by his wife, Mrs Khosla. However the insureds accepted that Mr Khosla had been a shadow or de facto director of all of the insureds at all relevant times, even during the periods when he was not a formal, de jure director listed as a director on Companies House.

Importantly, when the original policy incepted in 2013 and at each annual renewal when Mr Khosla was not a de jure director but was a de facto / shadow director, the insureds completed a proposal form containing the following question:

"The answers to questions 14 and 15 require full details from yourself, any member of your family directly connected with the business and your partners or directors.

14.  Have you or any director or partner been declared bankrupt, been a director of any company which went into liquidation, administration or receivership…

If so give details."

The insureds answered 'no', even though Mr Khosla's previous business (which was in fashion retail) had been placed into administration in 2006. He had been a director of that company. This fact was referred to in the judgment as 'Mr Khosla's Insolvency History'.

Decision

Failure to disclose insolvency history on the proposal form was not a misrepresentation

HHJ Rawlings, sitting as a High Court Judge, found that a reasonable person would not conclude that the meaning of "director" in Question 14 of the proposal form extended to de facto or shadow directors.

He therefore found that the insureds' answer on the proposal form did not constitute a misrepresentation.

He considered that a reasonable person submitting the insurance proposal would interpret Question 14 as asking only about individuals who were de jure directors. Even if they understood the concepts of de facto and shadow directors, the reasonable person completing the form would not expect that they were required to conduct a complex legal analysis to determine if someone is a de facto or shadow director.

Existence of a shadow director (and his insolvency history) was a material circumstance for disclosure

Although HHJ Rawlings found that answering 'no' to Question 14 was not a misrepresentation, he did find that Mr Khosla's status as a de facto or shadow director, and his Insolvency History was a "material circumstance" which ought to have been disclosed pursuant to section 18 of the MIA 1906 and section 3 of the IA 2015.

In reaching this conclusion, the judge provided a summary of the law on materiality, which was applicable to the IA 2015 as well as the MIA 1906. In particular:

• The burden is on the insurer to demonstrate materiality.
• The question is one of fact to be tested at the time of placement and assessed from the perspective of the "prudent insurer".
• The materiality threshold is low – the insurer must simply demonstrate that a prudent underwriter would have been influenced by the undisclosed facts. It is not necessary to show that the insurer would have refused the risk. In other words, if a fact is something that a prudent underwriter would not simply disregard entirely, it will be relevant to materiality.

The Court approved generally of the statements in Berkshire Assets (West London) Ltd v Axa Assurance UK PLC [2021] EWHC 2689 (Comm), outlining the relevant principles.

Even though Mr Khosla's Insolvency History was some time in the past, related to a different type of business and he had not been the subject of adverse comment in the administration, the Court found that a prudent underwriter would have taken these matters into account. Moreover, the fact that Mr Khosla was operating as a shadow director would also have been taken into account.

As a result, it was a material circumstance that should have been disclosed.

This aspect of the judgment also demonstrates the importance of ensuring experts are directed to answer the correct questions in their report. In this case, the insureds' expert was asked to consider whether the insurer would have cancelled the policies, had they known of Mr Khosla's Insolvency History. However HHJ Rawlings observed that the critical question was not the likely commercial approach of the insurer, but whether Mr Khosla's Insolvency History was a material circumstance. Since the question of materiality was only addressed by the insureds' expert at trial, and not in his report, the Court placed less weight on his opinion.

Insurer able to demonstrate they would not have written cover had they known of insolvency history

Next, the Judge had to decide whether the insurer would – as it asserted – have refused to continue providing cover if it had been told at inception of Mr Khosla's Insolvency History (i.e. inducement).

HHJ Rawlings observed that the onus is on the insurer to establish inducement.  It was common ground in the proceedings that the test for a "qualifying breach" under IA 2015 (which allows insurers a remedy against the insured for breach of the duty of fair presentation) is the same as the test for inducement at common law.

The question of inducement is a factual question for the Court, not one on which expert evidence was required.  The Court therefore did not place weight on the insureds' expert, who opined that insurer would not have cancelled the policies if it had known about Mr Khosla's Insolvency History.

The judge concluded that the non-disclosure was neither deliberate nor reckless. Nevertheless, based on the insurer's underwriting guidelines and oral testimony of relevant employees of the insurer, HHJ Rawlings accepted that the insurer would not have offered any cover had it known of Mr Khosla's Insolvency History.

Having proved inducement, it followed that the insurer was permitted to avoid the policy entirely.

Waiver

Finally, the insureds argued that the insurer had waived any requirement on the part of the insureds to give disclosure in respect of de facto and shadow directors because it had not mentioned such directors expressly in the proposal form.

The Court approved of the test for waiver outlined in Ristorante Limited T/A Bar Massimo v Zurich Insurance Plc [2021] EWHC 2538 (Ch), namely whether a reasonable man reading the relevant question would be justified in thinking that the insurer had restricted its right to receive all material information, and consented to the omission of specific information.

HHJ Rawlings found that a reasonable man would not conclude that the insurer had waived any requirement for the insureds to disclose that Mr Khosla ultimately controlled their management. Even though the proposal form asked only about the insolvency history of "directors" (meaning directors on the record, rather than shadow directors), Mr Khosla's status was an "unusual and material fact". Unlike in Ristorante, the proposal form expressly inquired about the whether any director of the insured had been a director of a company that had gone into administration. 

Comment

This is yet another judgment concerning the adequacy of disclosure of previous matters connected to insolvency. Insureds and their brokers should take great care in providing this information to insurers prior to inception. Tynefield shows just how broad the disclosure obligation can be: there was a requirement to disclose Mr Khosla's Insolvency History, notwithstanding that the insolvency event was over a decade earlier and involved an unrelated business.

The judgment is also a reminder that under the IA 2015 the onus is on the insurer to show inducement i.e. what they would have done had there not been a breach of the duty of fair presentation. The Court noted that this was a factual question and not one for expert evidence. Here the insurers provided sufficient evidence to persuade the Court that they would not have written the policy had they known a director had an insolvency history. Clear underwriting guidelines will be of significant assistance to insurers in this context.

Finally, this case demonstrates the importance of carefully briefing experts when preparing evidence. A failure to directly engage with the precise issues for determination is likely to undermine the weight the Court is prepared to place on expert evidence.