Law Commission and Scottish Law Commission Insurance Contract Law: The Business Insured s Duty of Disclosure and the Law of Warranties

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1 Law Commission and Scottish Law Commission Insurance Contract Law: The Business Insured s Duty of Disclosure and the Law of Warranties The Law Society of Scotland s Response October 2012 The Law Society of Scotland

2 INTRODUCTION The Obligations Law Sub-Committee (the Committee ) of the Law Society of Scotland welcomes the opportunity to comment on the Law Commission / Scottish Law Commission Joint Consultation Paper, Insurance Contract Law: The Business Insured s Duty of Disclosure and the Law of Warranties (SLC DP, No 155, 2012) (the Consultation ). GENERAL COMMENTS The Committee commends the Commissions for a readable Consultation document on a complex area of law that, we agree, is in pressing need for reform. We welcome opportunity to respond and we regret that we have not been able to respond to all of the questions in the Consultation. But we hope that, for those questions where we have been able to offer comment, our responses may be of some assistance. Our numbered responses refer to the summary of the questions as numbered in chapter 18 of the Consultation. SPECIFIC COMMENTS 18.2 Do consultees agree that there is a need to reform sections 18 to 20 of the Marine Insurance Act 1906 to clarify the duty of disclosure in business insurance? Response: Yes 18.3 Do consultees agree that the same legal regime should apply to all businesses, both large and small? If consultees think that special protections should apply to smaller businesses, please provide evidence of that need. Response: We would observe that the Committee responded to the Commissions Issues Paper 5 (July 2009) in terms that supported as the Commissions had suggested the extension of consumer contract law protections to micro-businesses. We note that the Commissions do not now propose to proceed with the suggestions contained within issues Paper 5. We appreciate that the Commissions have engaged in considered reflection on this questions after a period of consultation with various stakeholders. It is our position, however, that the Commissions The Law Society of Scotland

3 original suggestions and rationale were more persuasive that the new change of approach. It is unlikely that definition of a micro-business is as problematic as the application of that definition in practice. But such rules are applied, in other areas of the law, daily. The argument that the risks incurred by micro-businesses were too diverse, is hardly a point limited to micro-businesses. Individuals engage in all sorts of risks too. There may, instead, be an argument that mircobusinesses should be entitled to the protection of consumer contracts law for insurance taken out for a fixed list of risks (business premises, fire, theft etc). Outside the numerus clausus of those risks, ordinary commercial principles would apply. We think that this approach as pointed out by the International Underwriting Association of London 1 would allow the courts to develop the principles of insurance contract law as applied to commercial insurance contracts. At the moment, there is an understandable need for the judiciary to seek to ameliorate the full effects of commercial insurance contract law principles where this would create injustice in the case of a small business. Despite such laudable motives, however, the overall message may be to dilute legal certainty for commercial insurance contracts. The distinction too between a sole trader and a micro-business may increasingly become difficult to apply. French sole traders may now register for limited liability without creating a new legal person. Would a contract between such a sole trader and an insurance company registered in Scotland, and subject to English law, be subject to consumer contract law or commercial insurance contract law? We think the Commissions original idea to extend consumer protection to small businesses was sensible and realisable. We have no further evidence to produce. We refer instead to the persuasive case originally presented in the Consultation Paper in 2007 and in Issues Paper 5 in Do consultees agree that: (1) the essential elements of section 18(1) of the Marine Insurance Act 1906 should be retained, so that before entering into an insurance contract, a business policyholder should disclose every material circumstance which it knows or ought to know; but (2) that the concepts of material circumstance and knowledge should be clarified in legislation? (5.78) The Law Society of Scotland

4 Response: (1) We were surprised that no further consideration was given to the position in other European countries about the remedies for non-disclosure. We have some concern that the all or nothing approach of avoidance is in accordance with reasonable commercial expectations. We return to this point in our answer to the question asked at 18.8 below. (2) Yes 18.5 In particular, should legislation specify that: (1) a material circumstance is a circumstance required to provide a fair presentation of the risk? (2) A fair presentation of the risk should include; (a) Any unusual or special circumstances which increase the risk; (b) Any particular concerns about the risk which led the policyholder to seek insurance; (c) Standard information which market participants generally understand should be disclosed? (3) Where the insurer receives information which would prompt a reasonably careful insurer to make further enquiries, an insurer who fails to make appropriate enquiries should not have a remedy for non-disclosure of any fact which those enquires would have revealed? (5.79) Response: (1) Yes (2) Yes. In particular, we think that it would be useful to specify in legislation those matters which, across the insurance board, insurers would expect to be disclosed: insolvency events, criminal convictions and the like. (3) Agreed Do consultees agree that these principles would encourage insurers and policyholders to work together to improve pre-contract disclosure? Response: We are less hopeful that policyholders and insurers will work together. For most businesses, insurance contracts for standard risks are not negotiated. We do not see that changing. 1 Consultation, para A.14. The Law Society of Scotland

5 We would again suggest that it might make sense for protocols or standard disclosure forms to be developed for standard risks. It might be the case that in the case of more complex risks there could and should be closer cooperation between the insured and the insurer about the information to be disclosed. But the nature of bespoke and unusual risk is such that, at the proposal stage, neither party may know enough about the nature of the risk to be insured to ask meaningful disclosure questions Do consultees agree that other aspects of the doctrine of waiver can be left to the courts? Response: Yes Do consultees agree that: (1) If sections 18 to 20 of the Marine Insurance Act 1906 are to be amended the opportunity should be taken to include the inducement test within the statute? (2) The statute should provide that to obtain a remedy for non-disclosure or misrepresentation, the insurer must show that without the non-disclosure or misrepresentation it would not have entered into the contract at all, or would have done so only on different terms? Response: (1) Yes; (2) Yes in so far as it is incumbent upon the insurer to demonstrate that, in the absence of the nondisclosure it would not have assumed the risk at all. But we would not support a statutory provision to the effect that an insurer which would have assumed the risk but on different terms or at a different premium can escape liability in its entirety. We appreciate that the Commissions deal with proportionate remedies in chapter 9. We would say at this stage, however, that we see the proportionate remedies proposals being able to act as a control device in many cases of nondisclosure Do consultees agree that: (1) For the purposes of deciding what a business policyholder should disclose to an insurer before concluding an insurance contract, the issue The Law Society of Scotland

6 of what constitutes knowledge should be clarified in legislation? (2) Where a business policyholder is a corporate entity, knowledge should include information known to: (a) The directing mind and will of the organisation; and (b) The persons who arranged the insurance on behalf of the organisation? (3) For these purposes knowledge should mean: (a) Actual knowledge; and (b) Blind eye knowledge? (4) A business policyholder should also be under a duty to disclose information that would have been discovered by reasonable enquiries, which are proportionate to the type of insurance and to the size, nature and complexity of the business? Response: As a general comment we would suggest that it may be impossible to come up with workable rules that can apply at one and the same time to, first, a natural person, who knows her personal circumstances; and, second, a multinational corporation with tens of thousands of employees. One difficulty, perhaps, is the application of concepts appropriate to natural persons to juristic persons. A company has no more a directing mind than it has a soul. In this state of affairs, we would reiterate our provisional view that the difficulties may be ameliorated at the level of liability: in cases where the non-disclosed information would have resulted in cover nonetheless, but cover at a different rate, the insurer does not escape liability in full, but benefits rather from a proportional reduction in its liability. Subject to this caveat, however, we would respond to the specific questions asked as follows: (1) Yes (2) Yes, although we would question whether (a) and (b) should be cumulative as opposed to alternative. (3) We found this question more difficult. The question did not appear to focus on the separate issues, otherwise clearly encapsulated in para 6.53 between (a) attribution to a juristic person of a non-disclosure (whether negligent or fraudulent) of an employee preparing the disclosures; and (b) the obligation of the employee of a large organisation, whose responsibility it is to fill out the proposal form, to make inquiries within the organisation for the purposes of disclosure The Law Society of Scotland

7 (4) Similarly, we had doubts, under this head, whether this additional disclosure obligation was appropriate. In our view, the danger of this additional formulation is that, where the Commissions have attempted to bring clarity with the above recommendations, an additional disclosure requirement would re-introduce uncertainty Do consultees agree that: (1) Rather than distinguish between matters of fact and matters of expectation or belief, section 20 of the 1906 Act should be amended to distinguish between matters which the policyholder knew or ought to know about (as previously defined) and other matters? (2) Where the representation is one which the policyholder knew or ought to know about, it must be true? 212 (3) Where the representation is not one which the policyholder knew or ought to know about, it must be made in good faith? Response: We refer to the preliminary comments we have made with respect to the Alternative Control Device. In our view, in this area as in others, it is more likely to provide an efficient solution to these problems than a reformulation of old rules, even after the Commissions considered and able analysis, in more modern language. (1) Despite the Commissions commendably lucid summary of the existing law, we remain unconvinced that a reformulation of s 20 will lead to greater legal certainty. As the Commissions have already highlighted the knowledge, for a juristic person, is entirely fictitious. We doubt whether an extension of this fiction even in light of the Commissions proposals for refinement will provide much additional legal certainty. (2) This appears to be too absolute. A small error could render a disclosure untrue although that disclosure may not have affected the insurer s decision to provide cover, although it may have done so only at a different premium. Again, in our view the proposals on proportionate remedies may provide the most appropriate control device. (3) In these matters, we consider a refined obligation of good faith might be a better way of addressing these matters. The Law Society of Scotland

8 18.13 Do consultees agree that, where the policyholder s conduct is not dishonest, proportionate remedies should be the default regime for non-disclosure and misrepresentation in business insurance? Response: Yes Do consultees agree that the remedy should focus on the contract that the insurer would have entered into with the policyholder if the policyholder had fully complied with its duty of disclosure? In particular: (1) If the insurer would not have entered into the insurance contract at all, the insurer may avoid the contract? (2) If the insurer would have entered into the contract on different terms (excluding the premium), the contract is to be treated as if it included those terms? (3) If the insurer would have charged a higher premium, the insurer may reduce proportionately the amount to be paid on a claim (which may be additional to the inclusion of other terms)? Response: Yes Do consultees agree that the effect of a proportionate remedy on reinsurance can be left to freedom of contract between insurers and reinsurers? Response: Reinsurance is a specialised market on which it is appropriate to take soundings from those more specialised in the area than we are. We would mention only, however, that the rationale for introducing proportional remedies in commercial insurance generally do seem to us to apply with equal force to reinsurance. And given that insurers, who have to pay out under insurance policies may be reinsured, we would query whether it necessarily makes sense in this field to have a dual regime Where an insurer is entitled to apply a proportionate remedy to a claim, should the statute provide that: (1) the insurer has the right to cancel on reasonable notice; and (2) the policyholder has the right to cancel on reasonable notice? Response: Yes for both. The Law Society of Scotland

9 18.17 Do consultees think that the statute should provide a specific definition of deliberate or reckless non-disclosure and misrepresentation? Alternatively, should the statute refer to fraudulent conduct and leave this to the courts to define in accordance with the existing law? Response: We would query whether deliberate is an appropriate test for juristic persons. We would prefer, in theory, for the test to remain that of common law fraud. But, alas, it seems to us, in Scots law at least, that the test of common law fraud is not particularly clear either, particularly given the potentially wider meaning of fraud in Scots law compared to modern English law If deliberate or reckless conduct should be defined, should it be defined as conduct where the proposer: (1) had actual knowledge of the relevant facts (or shut its eyes to the relevant facts), and (2) (in the case of omissions) knew that the facts were relevant to the insurer, or did not care whether or not they were relevant to the insurer? Response: See our comment to above Where the proposer has behaved deliberately or recklessly, do consultees agree that the insurer should be entitled to: (1) avoid the policy and refuse all claims; and (2) keep any premium paid? Response: Yes in a case of fraud Do consultees agree that: (1) The parties to a business insurance contract should be entitled to contract out of the proportionate remedies for non-disclosure and misrepresentation in favour of the insurer through a contract term; but (2) that such a term is only effective if it is written in clear, unambiguous language and specifically brought to the attention of the other party before the contract is formed? Response: If our guiding principle is freedom of contract, this should be allowed. The difficulty is freedom of contract often allows organised and well-advised organisations, such as insurers, quickly The Law Society of Scotland

10 to undermine clarifications in the law by contracting out of much of the general law. Such clauses could be particularly problematic for the micro-business highlighted in Issues Paper 5 who rarely engage in genuine negotiation of insurance policies for standard risks Do consultees agree that the duty of good faith should continue as an interpretative principle, but should not in itself give either party a cause of action? Response: We think there should be continued reference to good faith. We think that, on balance, it makes sense to make no statement in the legislation about the effect of good faith. Good faith, in other areas of the law, is a dynamic term and it should be left to the courts to develop how good faith, in the twenty first century, should develop and the remedies that should evolve for a breach of good faith rather as has happened in other areas of the law Should section 17 refer to utmost good faith or simply good faith? Response: In our view a reference to good faith rather than utmost good faith would be desirable. (rather than uberrima fidei, which, with considerable justification, has been described as an alien, vague, useless expression without any particular meaning in law. 3 ) In one classic Scottish case, one experienced judge described the contract of insurance as being one of good faith on both sides Do consultees agree that, in business insurance, a term in a proposal form, contract or accompanying document which states that the policyholder warrants the accuracy of the answers given or that the answers form the basis of the contract should be of no effect? Response: Yes. The distinction between representations and warranties is not well understood by lawyers never mind business people. As the Commissions rightly say, these clauses tend merely to operate as a trap. It is clauses such as these that give rise to the impression that insurers can avoid liability for an insured risk at their discretion. 2 The implied term of mutual trust and confidence in labour law is a good example. 3 Mutual and Federal Insurance Co Ltd v Oudtshoorn Municipality 1985 (1) SA 419 (A) at 433C-F per Joubert JA, and quoted with apparent approval in Manifest Shipping Co Ltd v Uni-Polaris Shipping Co Ltd [2001] UKHL 1; [2003] 1 AC 469 at [5-7] per Lord Clyde. 4 Life Association of Scotland v Foster (1873) 11 M 351 at 364 per Lord Deas. Only Lord President Inglis (at 359) used the The Law Society of Scotland

11 18.24 Do consultees agree that where a warranty is not complied with: (1) the insurer s liability should be suspended; and (2) liability should be restored where the policyholder remedies the breach? Response: Yes to both Do consultees agree that sections 34(1) and 34(3) of the Marine Insurance Act 1906 should be retained? Response: Yes, although we would like to see some wording referring only to simple waiver in Scotland, rather than to waiver by election or by estoppel. A major source of legal uncertainty in an Act such as the 1906 Act, in Scots law, is a lack of thought being given to how English terminology translates into Scottish legal vocabulary Do consultees agree that where the policyholder breaches a warranty, the insurer s right to cancel the contract should be contractual rather than statutory, and therefore governed by the terms of the contract? Response: Yes Do consultees agree that: (1) In consumer insurance, a term which purports to put the consumer into a worse position as regards breach of warranty than that set out in the proposed reform should be of no effect? (2) In business insurance, a term which permits an insurer to refuse a claim (a) for a breach of warranty which was remedied before the loss; or (b) for breach of a term designed to reduce the risk of another type of loss (or loss at a different time or place) is only effective if it is written in clear, unambiguous language and specifically brought to the attention of the other party before the contract is formed? Response: (1) Yes. (2) Yes expression uberrima fides, which duty, he said, could be breached even in bona fide (at 359). Cf Lord Armillan at 371. The Law Society of Scotland

12 18.29 Do consultees agree that an express requirement that, in order to take effect, a warranty must be in writing is not necessary? Response: Yes The Law Society of Scotland

13 For further information and alternative formats please contact: Tel: The Law Society of Scotland Atria One, 144 Morrison Street Edinburgh EH3 8EX The Law Society of Scotland