Insurers’ “fraudulent device” defence abolished by the Supreme Court

Versloot Dredging BV and anor. v HDI Gerling Versicherung AG and ors [2016]

Date published

22/07/2016

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In a previous decision Popplewell J professed regret in holding to be good law and applying, the “tentative view” expressed by Mance LJ in Agapitos v Agnew (The “Aegeon”) [2002].

That view was that any lie by an insured in support of a claim that was otherwise entirely good was a fraudulent device that would lead to the claim being “forfeit” if the lie was intended to improve the insured’s prospects of obtaining a settlement, or a better settlement or winning the case and if it, objectively, yielded a “not insignificant” improvement in the chances of this. Therefore, because on one occasion, Mr Kornet, a director of the insured, recklessly claimed that the Master and/or crew had reported a bilge alarm going off some 9 hours before they in fact reported it, it was deprived of a Euros 3.2 million claim that was in fact held to be otherwise good, as if that claim had been a “fraudulent claim” in that the insured had entirely fabricated it or exaggerated it’s amount. We suggested that Popplewell J’s extensive consideration of the (what he felt to be) inflexibility and disproportionate effect of the principle amounted to an invitation to the Court of Appeal to overturn his decision and fashion the English principles as to “fraudulent devices” on more flexible and proportionate lines than those outlined in the “Aegeon.

The Court of Appeal, however, resolutely declined the Judge’s implied invitation and upheld his decision (see our Briefing). It applied Mance LJ’s reasoning in the “Aegeon” as the ratio of the case, considering it a proportionate way of effecting the policy underlying it of discouraging fraud in claims, and of depriving the assured the opportunity of making a “one-way bet”. Indeed its draconian effect was precisely what gave the doctrine its deterrent effect and its justification. The qualification that the Court did make to the “Aegeon” test was that the lie must make a “significant” (rather than “not insignificant”) improvement in the claim’s chances.

The Supreme Court’s decision

The end of the “Aegeon”’s doctrine of fraudulent devices

By a majority of 4:1 (Lords Sumption, Clarke, Hughes and Toulsen being the majority with Lord Mance, as he now is, constituting the minority) the Supreme Court has not simply re-caste the doctrine along flexible and proportional lines as suggested by Popplewell J, but has abrogated it entirely. What is now to be termed a “collateral lie” in support of a claim (i.e. “a lie which turns out when the facts are found to have no relevance to the insured’s right to recover”), will not entitle the insurer to reject the claim.

The reasoning of the majority

Lord Sumption, at the outset of his leading speech, characterised the appeal as being concerned with the situation where “the entire claim may be justified, but the information given in support of it may have been dishonestly embellished, either because the insured was unaware of the strength of his case or else with a view to obtaining payment faster and with less hassle.” This he distinguished from the situations where the whole claim was fabricated, or where a genuine claim had been dishonestly exaggerated in amount.

The starting point of his substantive analysis was that the insured’s right to an indemnity arose as soon as the loss was suffered, so that denying an entire claim because it was fraudulently exaggerated was indeed a forfeiture of it. The obvious and important difference between a fraudulently exaggerated claim and a justified claim supported by collateral lies was that in the former case “the insured’s dishonesty is calculated to get him something to which he is not entitled”; the law deterred this by preventing him from recovering even the honest part of the claim. This policy did not apply where the insured was trying to obtain no more than the law regarded as his entitlement and the lie was irrelevant to the existence of the claim or its amount: “In this case the lie is dishonest, but the claim is not”. Applying the fraudulent claims rule would only protect the insurer from the obligation to pay, or to pay earlier, an indemnity for which he has been liable in law ever since the loss was suffered: “The insured gains nothing from the lie that he was not entitled to have anyway, and the insurer loses nothing if he meets a liability that he had anyway”.

The “materiality” of the lie, Lord Sumption indicated, was properly addressed with hindsight, i.e. on the basis of the merits of the claim as they ultimately turned out to be, rather than [as the “Aegeon” test required], the time when the lie was made, and this was whether the test was that the lie should give rise to a “not significant” or a “significant” improvement of the claim’s chances. As, the “Aegeon” test of materiality was similar to the materiality test for pre-contractual misrepresentations and non-disclosures, it could not apply to lies in the course of making a claim for two reasons. First, the fraudulent claims rule required no impact on the mind of the insurer (i.e. no inducement) in order to operate, so it did not matter how the merits of the claim appeared at any particular moment as opposed to the merits as they actually were [found by the Court to be]. Second, at the claims stage, unlike the placing stage, the question was not one concerning the insurer’s discretion of whether or not to accept the risk and on what terms; but of whether or not the insurer was liable. Therefore, Lord Sumption considered that the only rational test of materiality of the lie must therefore be based on its relevance to a court which is in a position to find the relevant facts. The application of the fraudulent claims rule to lies which are ultimately found to be irrelevant was disproportionately harsh, went further than any legitimate commercial interest of the insurer could justify and, as Popplewell J pointed out, led to anomalous consequences.

Lord Hughes examined at greater length, the policy of deterrence underlying the fraudulent claims rule, and the question of its proportionality if applied to collateral lies.[ In particular, at para 98, he undermined the notion that the maker of a collateral lie makes a “one way bet”, since and has something to lose if found out, because of the risk of criminal prosecution and certain other forensic and costs considerations.

Lord Mance’s dissenting judgment

As might be expected, Lord Mance defended his exposition of the fraudulent devices principle in the “Aegeon”, with the exception of accepting the Court of Appeal’s modification that the lie should give rise to a “significant” rather than a “not insignificant” improvement of the insured’s prospects. He disagreed with the suggestion that considerations of proportionality, or the various other considerations referred to by Lord Hughes at para 98, entailed that the fraudulent claims principle did not encompass the use of “fraudulent devices”. In response to the majority’s arguments as to “materiality”, Lord Mance indicated that the decision to settle a claim amounted to a central underwriting decision, and that the insured’s lie was “told to influence the underwriter’s assessment of what a court would decide and thereby to induce the underwriter to pay the claim”. Therefore “its materiality can perfectly well; be, and must… be based on the relevance to that assessment and to the underwriters’ decision whether to pay”. Lord Mance highlighted that it could not be assumed all aspects of the claim would proceed to trial, and the retrospective nature of regarding an untruth as immaterial “simply because, perhaps years later, it can be seen that the lie was unnecessary and the claim good without it”. This, Lord Mance said, “was a charter for untruth”.

Conclusion

In our view, the basis of the majority’s agreement with Popplewell J – and disagreement with all three Court of Appeal judges and Lord Mance – was driven not to any real extent by principle, but by the policy value judgment that forfeiture of a claim was too draconian a sanction for a fraudulent device (now re-branded as the more sanitary sounding “collateral lie”).

The underlying analytical flaw with the majority’s position, in our view cogently exposed by Lord Mance, is that, in order to effect the objective of establishing the perceived disproportionate nature of the doctrine of the “Aegeon”, the majority denied the reality of the situation in which false statements are made in aid of a claim. That reality is, that unless and until, not only are proceedings started, but a judgment is given by the Court, it is unknown and unknowable whether the lie will ultimately be found to be “collateral” or will be decided to be relevant to the recoverability of the claim. Certainly that distinction cannot and will not be something that influences the insured as to the type of lie he makes in support of his claim. It is, in our view, thoroughly unsound to judge the culpability of what he does (and therefore the proportionality of the sanction applied to it) by what the Court decides later – if it ever decides it at all. There is no difference in principle, between making what may turn out to be a “collateral lie”, and a lie that may turn out to be an exaggeration of a claim.

The serious concerns that arise from the majority’s decision are, we suggest, encapsulated by the following passage from para 128 of Lord Mance’s judgment:

Abolishing the fraudulent devices rule means that claimants pursuing a bad, exaggerated or questionable claim can tell lies with virtual impunity. The same logic governs fraudulent devices as it does fraudulent claims generally. It is, as Lord Hobhouse said in The Star Sea, para 62:
… simple. The fraudulent insured must not be allowed to think: if the fraud is successful, then I will gain; if it is unsuccessful, I will lose nothing.

In short, on the approach advanced by the majority, the fraudulent device will advance the insurance recovery if undiscovered, and quite possibly lead to the recovery of a bad or exaggerated claim, and it will have no effect on any insurance recovery to which the assured may be entitled, even if it is discovered.”

This is exemplified by this case itself. At first instance, the insurers argued (amongst other things) that the loss was caused by the owners’ want of due diligence in relation to the inspection/maintenance of the bilge alarms and so not covered under the Inchmaree clauses in the policy. In the event, the Judge’s finding that the loss was proximately caused by perils of the sea, covered by another clause made this issue irrelevant. Mr Kornet’s “collateral lie”, was only collateral because of this finding some three years after the lie was made. At the time, for all he or anyone knew, the state of the bilge alarms might prove to be a determinative issue in the case, in which event his lie would have gone to the heart of the issues and constituted his claim a fraudulent one. Fortunately for the insured, this “one-way bet” has now paid off.