Identifying Contracts of Insurance: Recent Developments and New Reflections on an Old Problem. Robert Purves, 3 Verulam Buildings, Gray s Inn

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1 Identifying Contracts of Insurance: Recent Developments and New Reflections on an Old Problem Robert Purves, 3 Verulam Buildings, Gray s Inn The legislative background European legislation 1. Although the UK has regulated insurance business (i.e. the business of effecting and carrying out contracts of insurance) for many years, the regulation of that business now discharges the UK s obligation, under the EU Treaty, to implement the EU Insurance Directives. By way of example, the key provisions of the First Non-Life Directive (73/239/EEC) (as amended) ( 1NLD ) are as follows: 1.1. The general scope provision in Art. 1: 1.2. Article 6: 1. This Directive concerns the taking-up and pursuit of the self employed activity of direct insurance The classification by classes of activity referred to in this Article appears in the Annex. The taking up of the business of direct insurance shall be subject to prior official authorization. Page 1 of 28

2 1.3. Article 7(2): Authorization shall be granted for a particular class of insurance. It shall cover the entire class unless the applicant wishes to cover only some of the risks pertaining to that class 1.4. Annex A (Classification of risks according to classes of insurance), sets out various classes of business. 2. These provisions of the 1NLD are subject to several important qualifications: 2.1. There is no definition of a contract of insurance in EU insurance legislation or in the case law of the ECJ. There is only a description, in Card Protection Plan Ltd v Customs and Excise Commissioners (ECJ Case C-349/ 96) [1999] STC 270: 17. EC Council Directive 73/329 [i.e. the First Non-Life Directive] does not define the concept of insurance either. However the essentials of an insurance transaction are, as generally understood, that the insurer undertakes, in return for prior payment of a premium, to provide the insured, in the event of materialisation of the risk covered, with the service agreed when the contract was concluded. 18. It is not essential that the service the insurer has undertaken to provide in the event of loss consists in the payment of a sum of money, as that service may also take the form of the provision of assistance in cash or in kind of the types listed in the annex to EC Council Directive 73/239 as amended by EC Council Directive 84/ As confirmed by the Court of Appeal in FSA v Digital Satellite Warranty Cover Limited [2011] EWCA Civ 1413 (now subject to appeal to the Supreme Court), the general insurance directives are, in EU jargon, minimum harmonising. Lord Justice Patten, giving the judgement of the Court put the point this way: the language of 1NLD is generally only consistent in my view with each member state retaining the right to pass regulatory measures beyond those contained in the directives provided that they are not inconsistent with and do not undermine the level of control prescribed by the directives. Page 2 of 28

3 3. The result is that ultimately, subject only to the minimum requirements of the directives, it is FSMA 2000 and the subordinate legislation made under it that determines the scope of regulated insurance business in the UK. UK legislation 4. The FSA is responsible for the authorisation and supervision of firms that carry on, by way of business in the UK, a regulated activity as defined FSMA 2000 and in legislation made under that Act. 5. FSMA 2000, s. 19 sets out the general prohibition as follows: (1) No person may carry on a regulated activity in the United Kingdom, or purport to do so, unless he is (a) an authorised person; or (b) an exempt person. (2) The prohibition is referred to in this Act as the general prohibition. 6. FSMA 2000, s. 22(1)(a) provides that an activity is a regulated activity for the purposes of this Act if it is an activity of a specified kind which is carried on by way of business and relates to an investment of a specified kind. 7. The particular activities and investments that are of the specified kind for the purposes of section 22 are set out in FSMA 2000, Sch. 2 and in more detail in the Financial Services and Markets Act (Regulated Activities) Order 2001 (SI 544/2001) ( the RAO ). 8. In particular, RAO, Art. 10 identifies effecting contracts of insurance and carrying out contracts of insurance as regulated activities for the purposes of FSMA 2000, s Under RAO, Art. 3(1), a contract of insurance is defined as follows: a contract of insurance means any contract of insurance which is a contract of long-term insurance or a contract of general insurance. Page 3 of 28

4 10. Art. 3(1) goes on to indicate that a contract of insurance also includes various other business, as follows: a contract of insurance includes (a) fidelity bonds, performance bonds, administration bonds, bail bonds, customs bonds or similar contracts of guarantee, where these are (b) tontines; (i) effected or carried out by a person not carrying on a banking business; (ii) not effected merely incidentally to some other business carried on by the person effecting them; and (iii) effected in return for the payment of one or more premiums; (c) capital redemption contracts or pension fund management contracts, where these are effected or carried out by a person who (i) does not carry on a banking business; and (ii) otherwise carries on a regulated activity of the kind specified by article 10(1) or (2); (d) contracts to pay annuities on human life; (e) contracts of a kind referred to in article 2(2)(e) of the Consolidated Life Directive (collective insurance etc.); and (f) contracts of a kind referred to in article 2(3) of the Consolidated Life Directive (Social insurance); but does not include a funeral plan contract (or a contract which would be a funeral plan contract but for the exclusion in article 60 [of the RAO]) 11. Several observations can be made about this legislative structure: Insofar as there is a definition of a contract of insurance in RAO, Art. 3, it brings within the scope of insurance regulation contracts of general insurance and Page 4 of 28

5 contracts of long term insurance, which are in turn defined respectively as any contract falling within Part I of Schedule 1 to the RAO (general insurance) or any contract falling within Part II of Schedule 1 to the RAO (long-term insurance). Schedule I to the RAO is a schedule of the UK classes of general and long-term insurance business The majority of UK Class of general or long term insurance business are defined in terms of either contracts of insurance providing certain cover, or contracts of insurance upon certain assets, or contracts of insurance against certain risks. The result is that the definition in RAO, Art. 3(1) is entirely circular, unless one imports a definition of a contract of insurance There is no other definition of a contract of insurance under FSMA 2000, or in the RAO. Nor does EU law provide any definition of a contract of insurance beyond the general description in the Card Protection Plan case (set out above). The absence of any legislative definition of a contract of insurance, either at EU or UK level, means that it is both permissible (in EU law terms) and necessary (in both UK and EU terms) for the English Court to apply English common law decisions to determine whether a particular contract is properly defined as a contract of insurance (See the Court of Appeal decision in Digital Satellite Warranty at [6] and [60] for the most recent statement of this proposition.) Applying those common law decisions, some of the types of contract that are included within the scope of a contract of insurance under RAO, Art. 3(1) (see above) would not be contracts of insurance at all. A good example is contracts of guarantee. Also, some contracts that would be contracts of insurance at common law (for example some funeral-plan contracts) are excluded. In essence the rider to the RAO, Art 3(1) definition simply sets out a basket of contracts that are (or are not) regulated as insurance business, whatever their proper classification at common law. Page 5 of 28

6 FSA Guidance 12. In summary, therefore, the question of whether or not a particular arrangement is a contract of insurance falls to be determined according to the common law applied to the facts of the particular case, but informed by the legislative background. 13. The FSA s guidance on the identification of contracts of insurance is at Chapter 6 of its Perimeter Guidance Manual ( PERG 6 ) reflects this position: PERG 6.2.3G: PERG 6.4.1G: The Regulated Activities Order does not attempt an exhaustive definition of a 'contract of insurance'. Instead, it makes some specific extensions and limitations to the general common law meaning of the concept. One consequence of this is that common law judicial decisions about whether particular contracts amount to 'insurance' or 'insurance business' are relevant in defining the scope of the FSA's authorisation and regulatory activities, as they were under predecessor legislation. Although what appears [in PERG 6] is the FSA's approach, it cannot state what the law is, as that is a matter for the Courts. Accordingly, this guidance is not a substitute for adequate legal advice on any transaction. The starting point 14. The following summary in PERG 6 is a sensible reflection of the basic content of the common law: PERG 6.3.3G: PERG 6.3.4G: The courts have not fully defined the common law meaning of 'insurance' and 'insurance business', since they have, on the whole, confined their decisions to the facts before them. They have, however, given useful guidance in the form of descriptions of contracts of insurance. Page 6 of 28

7 The best established of these descriptions appears in the case of Prudential v. Commissioners of Inland Revenue [1904] 2 KB 658. This case, read with a number of later cases, treats as insurance any enforceable contract under which a 'provider' undertakes: (1) in consideration of one or more payments; (2) to pay money or provide a corresponding benefit (including in some cases services to be paid for by the provider) to a 'recipient'; (3) in response to a defined event the occurrence of which is uncertain (either as to when it will occur or as to whether it will occur at all) and adverse to the interests of the recipient. 15. Derived / summary terminology for this set of contractual outcomes, include that a contract of insurance results in an assumption of risk by the insurer and a transfer of risk from the insured to the insurer. 16. It is this transfer of risk that is the basis for the economic effect of insurance: instead of having to either (a) limit their range of activities to avoid a given risk; or (b) hold back capital to address the consequences if a given risk crystallises, companies and individuals can pay a premium to transfer that risk to an insurer, on the terms of and subject to the conditions of a contract of insurance. Contracts containing both insurance and non-insurance obligations General approach to the classification of contracts 17. Street v Mountford [1985] A.C. 809 concerned a contract for the occupation furnished rooms that was headed licence agreement and included a declaration by the occupier that the agreement did not amount to a protected tenancy under the Rent Acts. The House of Lords held that on a proper construction, the agreement conferred on the occupier exclusive possession for a term at a rent and the result was a tenancy, not a licence. Lord Templeman at p. 829 said: In the present case, the agreement dated 7 March 1983 professed an intention by both parties to create a licence and their Page 7 of 28

8 belief that they had in fact created a licence. It was submitted on behalf of Mr. Street [the landlord] that the court cannot in these circumstances decide that the agreement created a tenancy without interfering with the freedom of contract enjoyed by both parties. My Lords, Mr. Street enjoyed freedom to offer Mrs. Mountford [the tenant] the right to occupy the rooms comprised in the agreement on such lawful terms as Mr. Street pleased. Mrs. Mountford enjoyed freedom to negotiate with Mr. Street to obtain different terms. Both parties enjoyed freedom to contract or not to contract and both parties exercised that freedom by contracting on the terms set forth in the written agreement and on no other terms. But the consequences in law of the agreement, once concluded, can only be determined by consideration of the effect of the agreement. If the agreement satisfied all the requirements of a tenancy, then the agreement produced a tenancy and the parties cannot alter the effect of the agreement by insisting that they only created a licence. The manufacture of a five-pronged implement for manual digging results in a fork even if the manufacturer, unfamiliar with the English language, insists that he intended to make and has made a spade. 18. Agnew and another v The Commissioner of Inland Revenue and another [2001] UKPC 28 concerned a charge over the uncollected book debts of a company that left the company free to collect the debts and use the proceeds in the ordinary course of its business. The question was this was a fixed charge or a floating charge. Lord Millett, giving the judgement of the Court, rejected the ruling in the Court below that it was the intention of the parties, gathered from construction of the terms of the debenture that (unless the intention was unlawful) dictated how the debenture should be characterised: [32] Their Lordships consider this approach to be fundamentally mistaken. The question is not merely one of construction. In deciding whether a charge is a fixed charge or a floating charge, the Court is engaged in a two-stage process. At the first stage it must construe the instrument of charge and seek to gather the intentions of the parties from the language they have used. But the object at this stage of the process is not to discover whether the parties intended to create a fixed or a floating charge. It is to ascertain the nature of the rights and obligations which the parties intended to grant each other in respect of the charged assets. Once these have been ascertained, the Court can then embark on the second stage of the process, which is one of categorisation. This is a matter of law. It does not depend on the intention of the parties. If their intention, properly gathered from the language of the instrument, is to grant the company rights in respect of the charged assets which are inconsistent with the nature of a fixed charge, then the charge Page 8 of 28

9 cannot be a fixed charge however they may have chosen to describe it. A similar process is involved in construing a document to see whether it creates a licence or tenancy. The Court must construe the grant to ascertain the intention of the parties: but the only intention which is relevant is the intention to grant exclusive possession: see Street v Mountford [1985] AC 809, [1985] 2 All ER 289, at p 826 of the former report, per Lord Templeman. So here: in construing a debenture to see whether it creates a fixed or a floating charge, the only intention which is relevant is the intention that the company should be free to deal with the charged assets and withdraw them from the security without the consent of the holder of the charge; or, to put the question another way, whether the charged assets were intended to be under the control of the company or of the charge holder. 19. Therefore, categorisation / characterisation of a contract is a two stage process: Stage one: construe the agreement to determine the rights and obligations that the parties intended to grant to or impose on one-another Stage two: categorise the contract according to the content of the rights and obligations created. Construction of the contract 20. The basic principles applicable to the construction of contracts is well established: The primary source for understanding what the parties meant is their language interpreted in accordance with conventional usage: we do not easily accept that people have made linguistic mistakes, particularly in formal documents. (Bank of Credit and Commerce International SA v Ali and others [2001] UKHL 8, per Lord Hoffmann at [39]). 21. From that starting point, the construction or interpretation or a contract is an objective process by which the Court finds: the meaning which the document would convey to a reasonable person having all the knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract. (Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896 (HL) per Lord Hoffman at 912). Page 9 of 28

10 22. The knowledge reasonably available to the reasonable person is referred to as the background or in older cases the matrix of facts (Prenn v Simmonds [1971] 1 WLR 1381 (HL) per Lord Wilberforce at 1384). 23. Provided it was reasonably available to the parties the evidence which makes up the background includes (subject to well established exceptions covering, for example, previous negotiations, declarations of subjective intent and the conduct of the parties after the contract is made) anything which (a) a reasonable man would have regarded as relevant (Bank of Credit and Commerce International SA v Ali and others [2001] UKHL 8, per Lord Hoffmann at [39]); and (b) would have affected the way in which the language of the document would have been understood by a reasonable man. Classification of the contract 24. Once the rights and obligations created and imposed by the contract are identified, the categorisation or classification of the contract requires the Court to look at the contract with the aim of determining its substance or substantial effect. For example in McEntire and another v Crossley Brothers Ltd [1895] A.C. 457, per Lord Herschell LC, at p. 463: I quite concede that the agreement must be regarded as a whole - its substance must be looked at. The parties cannot, by the insertion of any mere words, defeat the effect of the transaction as appearing from the whole of the agreement into which they have entered. If the words in one part of it point in one direction and the words in another part in another direction, you must look at the agreement as a whole and see what its substantial effect is. But there is no such thing, as seems to have been argued here, as looking at the substance, apart from looking at the language which the parties have used. It is only by a study of the whole of the language that the substance can be ascertained. 25. The same (or a very similar) principle has long been applied in relation to the classification of contracts of insurance: In re Law Guarantee Trust and Accident Society Limited, Liverpool Mortgage Insurance Company s case [1914] 2 Ch 617 (CA), per Buckley LJ At 631b-c: Page 10 of 28

11 In arriving at the conclusion that this tripartite contract is one not of suretyship but of insurance, I have founded myself not at all upon any language in the documents. The true effect of the contract is to be ascertained, I think, not upon a scrutiny of the terms used but upon an examination of its effect In Hampton v Toxteth Co-operative Provident Society [1915] 1 Ch 721 Lord Cozens-Hardy MR stated, in relation to the company s marketing material which boasted free life assurance as a benefit: I was glad to receive from the society s counsel a distinct assurance that no such statements will in future be made. But however reprehensible they may be, it seems to me that they cannot by calling something which is not an assurance by that name make it a policy of assurance within the meaning of the Act [in this case, The Insurance Companies Act 1909] In re Sentinel Securities plc [1996] 1 WLR 316 considered a so-called guarantee scheme and concluded that it was in fact a scheme of insurance and not of guarantee. The Court in this case confirmed the earlier decisions to the effect that it is the substance of the provider s obligation that determines the substance of the contract and that the form of the contract is not decisive as to whether it is or is not a contract of insurance. Rattee J at said: I do accept that the contract in the present case has many attributes not usually found in contracts of insurance, but I accept the Secretary of State's submission that I must look at the substance of the obligation being undertaken by the company. That is, it seems to me, an obligation to protect the customer against one of the effects of the supplier ceasing to trade because of financial failure, bankruptcy or liquidation, by providing the customer with a substitute in that event for the loss of benefit of the supplier's guarantee, such substitute being the company's obligation to carry out the same services itself which the supplier had bound itself to do, subject to the limits stated in the guarantee protection scheme contract. In other words, the company undertakes, for a consideration, to provide the customer with compensation in kind for loss suffered in an uncertain event, namely financial failure of the supplier. This seems to me to be of the essence of a contract of insurance. Page 11 of 28

12 The mixed grill 26. So far, so relatively straightforward: it is the substance of the contract, not its form or the words in which it is expressed, that dictate its classification ( substance over form ). It is the substance of the contract, not the intention of the parties, that dictates is classification ( substance over intention ). 27. But the application of this analysis is difficult when a contract contains a number of different obligations, each of which is significant or substantial, but one or more of which could, if they were the subject matter of a separate contract, cause that separate contract to be characterised as a contract of insurance. What happens then? Is the contract necessarily a contract of insurance? Colloquially, this is the problem of the mixed grill after the following obiter passage from the judgement of Sir Robert Megarry V-C, in Medical Defence Union Ltd v Department of Trade [1979] 2 WLR 687: I think that my decision [that the contract in issue is not a contract of insurance] makes it unnecessary to explore the concept which during the hearing was referred to as a mixed grill. If a body carries on business which in part falls within the term insurance business and in part is outside it, does the [Insurance Companies] Act of 1974 apply? Is it a question of how much of the business is one and how much the other? Is the question to be determined by cost, or by the number of persons concerned, or by some other means, and, if so, what? These are matters of some difficulty. What is required is the business of effecting and carrying out contracts of insurance and not merely contracts for insurance. A contract which provides for insurance and other things may well be a contract for insurance; but is it a contract of insurance? Prepositions may indeed be important in this field: see Gould v Curtis [1913] 3 K.B. 84, 94, 98. The principal object of the contract? 28. One approach to the mixed grill problem is to give primacy to the principal object of the contract: the various obligations in the contract are weighed up, and the contract as a whole is classified by the reference to the main, dominant or principal obligation, to which the other obligations can sensibly be described as ancillary or subsidiary. The question then is simply whether that principal obligation is, or is not, insurance. Page 12 of 28

13 Authority against a principal object analysis 29. Beguiling though this approach is, its problem is that (generally, but see below), the English Court has rejected it: Prudential v Commissioners of Inland Revenue [1904] 2 KB 658 concerned a contract that provided a death benefit and an endowment benefit. The endowment benefit was larger. The Revenue argued that the endowment part was not insurance because surviving to a stated age could not be said to be adverse to the interests of the assured. It argued as a result that the contract as a whole fell to be classified by reference to the more substantial part, and was not insurance. Channell J disagreed, holding (at p. 664) that for the purpose of determining whether the contract comes within the definition we must look at it as a whole and not split it up into two separate parts Wooding v Monmouthshire and South Wales Mutual Indemnity Soc. Ltd [1939] 4 All ER 570 (HL) dealt with a contract between a mine owner and a mutual association that indemnified the owner against his statutory liability to compensate injured workmen. The contract provided for an initial period during which the mine owner capitalised a fund out of which the association would pay claims relevant to his business. At the end of that period the association would assess the future liability in respect of those claims, charge a further premium if necessary and take over liability (and the risk) outright. The association argued that it was not an insurer for the first period, merely an agent to disburse the fund capitalised by the owner. If that was right, the contract would not be a contract with insurers and, on the insolvency of the mine owner, the injured miners would not benefit from a statutory transfer of rights against the association. The House of Lords refused (per Lord Atkin, at 583D) to dissect the contract into two parts, or to split the transaction into two disparate bargains, noting that the contract remained throughout a contract to indemnify against unforeseen events. The fact that for the first period the association was entitled to demand a complete reimbursement was irrelevant (per Lord Wright, at 596 A.) Page 13 of 28

14 29.3. The Maria (No. 2) [1984] 1 Lloyd s Rep 660 concerned a contract of marine insurance. The question was whether that contract was void because it was a contract by way of gaming or wagering under Marine Insurance Act 1906, s. 4. Hobhouse J took the following approach to the characterisation of the contract, at 667: The contract (unless clearly severable) has to be looked at as a whole and characterised as a whole. If it is a wagering contract it fails wholly; there is no principle upon which the Courts can remake a contract so that it can be recognised in a valid form L'Alsacienne Premiere Societe Alsacienne v Unistorebrand International Insurance AS [1995] LIRLR 333 dealt with an indemnity that was part of a wider agreement concerning liabilities arising in a reinsurance pool. The question was whether the indemnity relating to reinsurance liabilities should itself be classified as reinsurance. Rix J held that it should not, at p. 348: I do not think the agreement can be picked apart into separate strands for the purpose of categorising individual elements, in effect single clauses within it, as contracts of a particular nature. The agreement must be construed as a whole and either it is to be regarded as a contract of reinsurance, or such characterisation is inappropriate Fuji Finance Inc v Aetna Life Insurance Co Ltd [1997] Ch 173 (CA) dealt with a contract of unit-linked life assurance, with a substantial investment element, reflected in the fact that the death benefit and the surrender value were the same the market value of the units on the relevant date. The Court of Appeal held that the correct approach was to consider the characterisation of the contract as a whole and to ask whether so read it was a policy of life insurance. Morritt LJ said at 189F-G: as Sir Donald Nicholls V-C. observed [1995] Ch. 122, 132, the whole policy is clothed in the vesture of life insurance, which is at least relevant, though by no means conclusive, to the characterisation of the policy. For my part I would accept the submissions of counsel for Fuji that the scope of and regulatory consequences which might arise under the Insurance Companies Act 1982 and the Financial Services Act 1986 are not relevant to this issue, but that question does not arise in the view that I have taken. Further, I do not accept that Sir Donald Nicholls V.-C. by his reference, at p. 133, to the principal object of the insurance indicated that he was adopting some inappropriate test. Reading Page 14 of 28

15 his judgment on this issue as a whole it is clear that Sir Donald Nicholls V.-C. was correctly considering the characterisation of the policy as a whole and posing the question whether so read it was a policy of life insurance. On analysis, the court found that the death benefit was obviously an insurance benefit and that the surrender benefit was sufficiently related to life or death for the policy as a whole to be characterised as a contract of life insurance. It was not relevant that the value of the death benefit and the surrender benefit were the same. Authority in favour of a principal object analysis? 30. In Card Protection Plan v Customs and Excise Commissioners [2001] UKHL 4 the House of Lords had determine (following a referral to the ECJ) whether a contract for the provision of a range of credit card protection services amounted to a single insurance supply under VAT legislation. The question was not whether the contract was a contract of insurance, since under VAT legislation an insurance supply could equally arise where (as in this case) the provider simply arranged for the customer to be covered under a block policy. The House found that the substance of the contract was for provision of insurance and the other services provided were ancillary or incidental to that main purpose, so that there was a single insurance supply for VAT purposes. Lord Slynn at p said the following: [22] It is clear from the Court of Justice's judgment that the national court's task is to have regard to the essential features of the transaction to see whether it is several distinct principal services or a single service and that what from an economic point of view is in reality a single service should not be artificially split. It seems that an overall view should be taken and over-zealous dissecting and analysis of particular clauses should be avoided. [23] I accept that it is possible, as Mr Paines has contended, to find that some of the 15 points if separated out and seen in isolation do not on the face of it provide for insurance as commonly understood. For example, point 1 provides only for an accurate computer record; point 6 provides for a change of address service; point 13 provides for a computer update service. [24] But there are points which indisputably provide for insurance of the most obvious kind. Thus point 2 provides for 750 cover for fraudulent use on any one claim; point 3 provides Page 15 of 28

16 for 750 cover up to the moment of the call to notify CPP After that your protection against fraudulent use is unlimited. These points reflect the insurance provided in section A of the policy issued by Continental to CPP for which clients are assured. Others it seems to me fall within class 18 ( Assistance ) in point A of the annex to the First [Non-Life] Insurance Directive, 73/239/EEC, as amended by Council Directive 84/641/EEC, eg points 4, 9, 10, 11 and 12 since it is clear that the service may consist of cash or acts in kind for the purposes of the Sixth Directive, 77/388/EEC. [25] If one asks what is the essential feature of the scheme or its dominant purpose, perhaps why objectively people are likely to want to join it, I have no doubt it is to obtain a provision of insurance cover against loss arising from the misuse of credit cards or other documents. That is why CPP is obliged to, and does, arrange, through brokers, with an insurance company like Continental for that cover to be available. [26] For the loss to be kept to the minimum it is valuable that the client should be able to notify CPP of the loss of a card and that CPP should be able to notify the company issuing the credit card. It is particularly useful if the client is abroad. For this purpose CPP needs an up-to-date record of cards with the necessary details and the client needs a replacement card if cards are stolen or lost. To assist in the administration of the scheme, luggage tags and a medical warning card are useful. Yet all of these are ancillary or incidental to the main objective of the scheme, ie financial protection against loss. The fact that the emergency cash advance and the cost of an emergency air ticket have to be reimbursed does not prevent those services from falling within Assistance in class 18 of the First Insurance Directive, 73/239/EEC. They clearly fall within the Court of Justice's definition of insurance. [27] The dominant purpose in my view is thus plainly one of insurance principally as to the provision of 750 and then of unlimited protection under reasons 2 and 3 but also in the other financial provisions such as those for dealing with seeking police help and pursuing claims in reason 8. [28] In so far as there are services which are not independently to be categorised as insurance they are in my view ancillary and in some cases minor features of the plan. They were, as CPP contends, preconditions to the client making a claim for cash indemnity or assistance or a precondition of the furnishing of insurance cover. I doubt whether they can in any event be regarded as sufficiently coherent as to be treated as one separate supply but even if they can it is ancillary to the provision of insurance. To regard the provision of insurance as ancillary or Page 16 of 28

17 subsidiary to the registration of credit card numbers is unreal and the consequences for the client of being able to take protective action with CPP with whom the cards are registered is closely linked to the insurance service. It is not possible to say that some elements of the transaction are economically dissociable from the others. 31. Taken overall, although the Court in Card Protection Plan uses principal object terminology, it is difficult to see this case (which was not concerned with determining whether the contract in question was a contract of insurance) as clear authority overturning the Court of Appeal s rejection of the principal object test in Fuji v Aetna, in favour of the characterization of the contract as a whole. 32. Nevertheless, the principal object terminology has its supporters, notably the authors of McGillivray on Insurance Law (Birds et al., 12 th ed., Sweet & Maxwell, 2012, at paragraph 1-008): When a contract of sale or for services contains elements of insurance it will be regarded as a contract of insurance only if, taking the contract as a whole, it can be said to have as its principal object the provision of insurance. 33. This passage has been cited with approval in two (relatively) recent first instance decisions and the Court of Appeal. Dix and another v Frizzell Financial Services [2008] EWHC (Costs) (a decision of Deputy Maseter Williams) and Morris and another v London Borough of Southwark [2010] EWHC B1 (QB). Both cases dealt with conditional fee agreements under which, instead of the client buying insurance cover for adverse costs, the solicitor provided an indemnity. It was argued that the provision of the indemnity was unauthorised insurance business and the conditional fee agreement was therefore unenforceable under FSMA 2000, ss. 23 and 26. This argument was rejected in both cases for substantially the same reasons. In Morris, Macduff J said: 44. I have reached the conclusion that this argument really does not bear detailed examination. There is no statutory definition of insurance, and it is clear that the courts have repeatedly held and affirmed that a contract of insurance does not have to have a premium. On the other hand, as Mr James has pointed out, the payment of premium or the non-payment of premium might provide a valuable pointer. Page 17 of 28

18 45. I have been referred to the following extract from McGillivray on Insurance Law. I do not apologise for quoting it, word-for-word, reflecting as it does my own view, 'It is sometimes necessary to decide, in the context of fiscal or regulatory legislation, whether a contract containing insurance and non-insurance elements should be classified wholly or partly as a contract of insurance. The inclusion of indemnity provisions within a contract, or the supply of services, neither makes the indemnifier an insurer, nor justifies describing the contract as wholly or partly one of insurance. Where a contract for sale, or for services, contains elements of insurance, it will be regarded as a contract of insurance only if, taking the contract as whole, it can be said to have as its principal object the provision of insurance.' 46. In my judgment, this, on any view, was a contract for the provision of legal services. The indemnity clause, whether looked at individually or as part of the contract, was a subsidiary part of the contract. In his oral submissions, Mr Bacon adopted what might be called 'the bystander test'. Anybody, he submitted, looking at this agreement, would say, 'Well, this is really providing insurance'. With respect, I would beg to differ; the bystander looking at this agreement, would say to himself or herself that this was a contract for the provision of legal services, with an indemnity clause whereby the solicitor undertook to pay the opponent's costs, in the event that that became necessary. To characterise it as a contract of insurance, albeit that the indemnity created some principles similar to an insurance contract, is to go too far. 34. Leave to appeal on this issue was refused and in Sibthorpe and another v London Borough of Southwark [2011] EWCA Civ 25, Lord Neuberger MR (with whom Gross and Lloyd LJJ agreed), considered whether that was the correct outcome: [58] That leaves the issue on which Waller LJ refused permission to appeal, namely whether the CFA is rendered unenforceable because, owing to the inclusion of the indemnity, it is a contract of insurance within the meaning of art 10 of the Financial Services and Markets Act (Regulated Activities) Order 2001 ( the 2001 Order ). If it is, then the indemnity, and hence, it is said, the CFA, could only have been entered into by an authorised or exempt person by virtue of s 19 of the 2000 Act, and, as the Solicitors were not authorised or exempt, the CFA is said to be void by virtue of s 26(1) of the 2000 Act. Page 18 of 28

19 [59] I am of the view that permission to appeal this point should not be granted. I think that the Judge was right in his view and reasoning on the point, which he expressed in the following terms [2010] EWHC B1 (QB), paras Lord Neuberger then quoted in full paragraphs [45] and [46] of Morris (set out above) and concluded (at [60]) that he would refuse permission to appeal on the insurance issue. 36. It is striking, however, that the principal object test as formulated in McGilivray and cited in these cases, also puts significant weight on the evaluation of the contract as a whole. The test is whether taking the contract as a whole, it can be said to have as its principal object the provision of insurance. It is tempting to conclude that there is not very much daylight at all between the approach in Fuji v Aetna and this approach, so that like Sir Donald Nicholls V.-C in Fuji the authors of McGilivray are not by [their] reference to the principal object of the insurance adopting some inappropriate test [but] correctly considering the characterisation of the policy as a whole and posing the question whether so read it was a policy of insurance. 37. Waller J seems to have had this sort of synthesis in mind in Digital Satellite at first instance: [84] The principal object test may or may not be the appropriate test when it comes to deciding whether elements of insurance bring a contract containing both insurance and noninsurance elements within the concept of a contract of insurance. But even assuming that it is, it cannot require, in every case, that a single principal object be identified. A contract may have two important elements, albeit that one is more significant than the other but it would not be right to categorise the nature of the contract by reference only to the more important element. What the principal object test is surely getting at is that there is to be a found a principal object [only] where the other elements are either ancillary or minor (to use descriptions found in the Card Protection Plan case) to a main objective of providing cover in the case of breakdown or malfunction or, to use other words, where those elements are integral with or subsidiary to a main object. Page 19 of 28

20 The FSA s approach to the classification of contracts containing multiple obligations 38. The FSA s guidance in PERG 6 (published in 2005 and not updated since) deals with contracts containing multiple obligations in the following two pieces of guidance: PERG 6.5.4G: The FSA will apply the following principles of construction to determine whether a contract is a contract of insurance. (1) In applying the description in PERG G, more weight attaches to the substance of the contract, than to the form of the contract. The form of the contract is relevant (see PERG 6.6.8G (3) and (4)) but not decisive of whether a contract is a contract of insurance: Fuji Finance Inc. v. Aetna Life Insurance Co. Ltd [1997] Ch. 173 (C.A.). (2) In particular, the substance of the provider's obligation determines the substance of the contract: In re Sentinel Securities [1996] 1 WLR 316. Accordingly, the FSA is unlikely to treat the provider's or the customer's intention or purpose in entering into a contract as relevant to its classification. (3) The contract must be characterised as a whole and not according to its 'dominant purpose' or the relative weight of its 'insurance content': Fuji Finance Inc. v. Aetna Life Insurance Co. Ltd [1997] Ch. 173 (C.A.) Read with PERG 6.6.7G : Under most commercial contracts with a customer, a provider will assume more than one obligation. Some of these may be insurance obligations, others may not. The FSA will apply the principles in PERG G, in the way described in (1) to (3) to determine whether the contract is a contract of insurance. (1) If a provider undertakes an identifiable and distinct obligation that is, in substance an insurance obligation as described in PERG G, then, other things being equal, the FSA is likely to find that by undertaking that obligation the provider has effected a contract of insurance. (2) The presence of an insurance obligation will mean that the contract is a contract of insurance, whether or not that obligation is 'substantial' in comparison with the other obligations in the contract. Page 20 of 28

21 (3) The presence of an insurance obligation will mean that the contract is a contract of insurance, whether or not entering into that obligation forms a significant part of the provider's business. The FSA generally regards a provider as undertaking an obligation 'by way of business' if he takes on an obligation in connection with or for the purposes of his core business, to realise a commercial advantage or benefit. A trap for the unwary 39. Practical experience has demonstrated that this guidance must be analysed applied with particular care. A literal reading of PERG 6.6.7G(1) is that that any contract containing a distinct obligation falling within the description in Prudential case (set out in FSA guidance at PERG 6.3.4G ) is necessarily a contract of insurance unless other things are not equal that is unless there is some relatively unusual factor in play in a particular case. 40. This literal interpretation is beguiling (both for the FSA and for those advising clients) because it looks like a bright line test and is relatively quick and easy to apply. However, there is a vast range of contracts that contain indemnities and other obligations that match the broad description in the Prudential. The result is potentially to extend the scope of FSA insurance regulation well beyond its proper limits. The literal interpretation leads to multiple contradictions 41. PERG 6.5.4G sets out the principles of construction / classification. Under PERG 6.5.4G(1) and (2) the substance of the contract prevails over the form of words or party intention. In addition and importantly, following the line of authority culminating in Fuji v Aetna under PERG 6.5.4G(3), set out above, the contract must be characterised as a whole. The guidance is specific (relying on the authority of the Court of Appeal) that this process does not involve weighing any insurance content in the contract against other content in order to derive the contract s dominant purpose by reference to relative weights. 42. From this it can be seen that the literal interpretation of PERG 6.6.7G(1) is problematic on many levels: Page 21 of 28

22 42.1. It flatly contradicts the guidance in PERG 6.5.4G(3) because a contract would be classified as insurance if it contains a particular obligation, without any consideration of the contract as a whole and whether or not the contract as a whole should be classified as insurance; It contradicts the approach that the FSA takes elsewhere in PERG 6. For example, PERG 6.7.7G notes that a simple manufacturer s or retailer s warranty is an identifiable and distinct obligation that is similar to and capable of being described as an insurance obligation in substance, under PERG 6.3.4G [the description in Prudential]. But, PERG 6.7.8G and 6.7.9G go on to say that: Notwithstanding PERG G, the FSA's view is that an obligation that is of the same nature as a seller's or supplier's usual obligations as regards the quality of the goods or services is unlikely to be an insurance obligation in substance. The FSA is unlikely to classify a contract containing a simple manufacturer's or retailer's warranty as a contract of insurance, if the FSA is satisfied that the warranty does no more that crystallise or recognise obligations that are of the same nature as a seller's or supplier's usual obligations as regards the quality of the goods or services. (Emphasis added) It contradicts the more general proposition (which has the force of common sense as well as commercial and judicial experience), that not every contract containing, for example, an indemnity or warranty within the description in Prudential is (or should be) classified or regulated a contract of insurance. As PERG 6.4.4G says: In some cases transactions with the same commercial purpose or economic effect may be classified differently, i.e. some as insurance and some as non-insurance. The literal interpretation is unsupported by authority 43. PERG 6 offers no authority for a literal interpretation of PERG 6.6.7G(1) and as far as I am aware, there is none. Indeed, so far as the Courts have considered the literal interpretation of PERG 6.6.7G(1), they have doubted that it is correct. In Re Digital Satellite Warranty Cover Ltd and others [2011] EWHC 122 (Ch), Warren J said this: Page 22 of 28

23 [82] In deciding whether a contract requires authorisation, the test propounded by the FSA in most cases is whether the contract contains an identifiable and distinct obligation that is, in substance, an insurance obligation : see the FSA's Perimeter Guidance (PERG) 6.6.7(1). This test is to be applied in deciding whether a contract which contains both insurance and noninsurance elements is to be classed as a contract of insurance. [85] The FSA's approach is to identify discrete elements. When it comes to determining whether a contract which contains both insurance and non-insurance elements is a contract of insurance requiring the insurer to be authorised, a strict application of such a test could result in contracts of insurance being found where the insurance element is insubstantial. It may or may not be right to go that far. I rather doubt that it is, especially given the acceptance by the FSA that an ordinary manufacturer's warranty provided as part of a sale agreement does not give rise to a contract of insurance. So, it seems to me at least, the FSA's statement in the Perimeter Guidance has to be tempered to some extent. The better analysis 44. No doubt the drafting of PERG 6.6.7G(1) could be improved, but there is in my view a less literal and more careful reading of it that resolves any contradiction. 45. PERG 6.6.7G(1) refers specifically to an insurance obligation as described in PERG G. That is not a reference to any obligation falling within the description in Prudential (i.e. within PERG 6.3.4G), but something much less common. It is a reference to an insurance obligation that both (a) falls within the description in Prudential); and (b) the presence of which in the contract compels the conclusion that the contract as a whole is properly characterised as a contract of insurance. 46. Read in that way, each of the sub-clauses to PERG 6.6.7G makes sense and is not redundant: PERG 6.6.7G(1) makes sense because unless there is some other factor in play, the FSA is indeed likely to conclude that a contract containing an obligation of that kind is a contract of insurance. It is not redundant because for example the RAO and other subordinate legislation under FSMA 2000 exclude certain Page 23 of 28

24 common law contracts of insurance from the scope of what is regulated as insurance under FSMA 2000 (see PERG 6.3.2G). So it is perfectly possible that even if the result of the process of construction is that a contract of insurance is identified, the provider has not, by writing that contract, carried on the regulated activity of effecting a contract of insurance PERG 6.6.7G(2) makes sense because if the presence of a particular obligation in a contract compels the conclusion that the contract as a whole is a contract of insurance, then (following the Court of Appeal in Fuji) it does not matter whether some metric can be identified (for example the number of other obligations in the contract, or the relative value of the insurance) by which that obligation can be said to be less substantial than another obligation. All of that will have been factored in to the decision as to whether the contract as a whole should be characterised as a contract of insurance PERG 6.6.7G(3) simply makes the point that if by writing a contract of insurance a person has carried on the regulated activity of effecting a contract of insurance, then it is no answer to say that writing that contract is only a small part of the provider s business. 47. In summary, therefore, my view is that (a) if properly interpreted PERG 6.6.7G does not contradict or undermine the principles of construction at PERG 6.5.4G; and more importantly, (b) the specific guidance at PERG 6.6.7G(1) cannot sensibly be read as necessarily bringing within the scope of the FSA s insurance perimeter any contract that contains an obligation that matches the broad description in the Prudential case. 48. The FSA is of course required to act in accordance with its own guidance, properly interpreted. R (on the application of Davies and others) v Financial Services Authority [2003] EWCA Civ 1128, (Kennedy, Mummery and Carnwath LJJ) considered whether the FSA had acted incompatibly with its own published guidance in the Handbook when in deciding to ban the applicant from performing controlled functions: [3] The Authority [i.e. the FSA] is the independent, nongovernmental regulator of the financial services industry under the 2000 Act. It is required to discharge its statutory Page 24 of 28

25 responsibilities in accordance with the provisions of the 2000 Act and its Handbook of Rules and Guidance. 49. Technically, of course, the Perimeter Guidance Manual is not part of the FSA Handbook itself, but is published alongside the Handbook. However it would be surprising if that difference were to undermine the point made by the Court of Appeal in Davies. Classification of the contract as a whole 50. What then, does the classification of the contract as a whole require? I draw the following principles from the cases: The courts have a strong preference to classify the contract as a whole, and a strong preference against dividing what was intended to be a single contract into component parts. It will be observed that in none of the cases cited above did the Court concede that there was, on proper analysis, a mixed grill Classifying the contract as a whole is not a mechanistic exercise that entails the minute analysis and classification of every obligation under the contract and the weighing of each obligation to determine whether, overall, insurance dominates or not. Classification as a whole reflects an evaluation and a judgment as to whether the substance of the provider s obligation is insurance References to the substance of the contract or the substance of the provider s obligation should, in my view, be understood in the same way as requiring an evaluation of and a judgment about the contract as a whole In reaching a judgment about the classification of the contract as a whole the Courts are likely to put little weight on how the parties name or describe their contract if this does not reflect the reality of the substance of the obligation provided. What matters is what the contract is, not what it is called As PERG 6 indicates, the presence or absence of typical insurance obligations (for example obligations of utmost good faith) and terminology will provide pointers, but is unlikely to be conclusive. Page 25 of 28

26 50.6. In difficult cases (for example where there is no contract benefit that unequivocally compels the conclusion that the contract is, or is not, a contract of insurance), the Court is likely to put relatively more weight on the purpose of the relevant legislation, and on the ordinary commercial understanding of insurance and the consequences of regulation. 51. Re OT Computers Ltd (in administration) [2003] EWHC 2490 (Ch) exemplifies the importance of the statutory context and regulatory consequences. The case dealt with extended warranties on computer equipment Sir Andrew Morritt V-C had to decide whether the warranty contracts gave customers rights under the Third Parties (Rights Against Insurers) Act 1930: [28] The extended warranties in this case are provided by the original supplier, the company, on payment of an additional fee financed by FNTF to the purchaser of the computer. They cover 'electrical and mechanical component failure'. In such an event, subject to specified exclusions, the company is to repair or replace the defective component. The fee for the extended warranty contract increases with any extension of the period within which the failure is to occur and is on a 'collect from and return to the customer basis'. In some cases the extended warranty contract also covers loss of or damage to the component from any sudden and unforeseen cause other than fire, but including theft. [29] Thus the extended warranty contracts, as counsel for FNTF accepted, do have the attributes of a contract of insurance. Counsel for FNTF also emphasised that the contract is with the company as the original supplier, not with the third party as an insurer, and is essentially an optional add-on to the original contract. Counsel for the administrators, on the other hand, relies on the circumstance that the extended warranty contract is a separate contract and is optional. [30] In my view, the extended warranty contracts are not contracts of insurance for the purposes of the 1930 Act, so that the liabilities of the company thereunder are not excluded from the ambit of the expression 'liabilities to third parties' in s 1(1) as provided by s 1(5). The question is not, I think, whether they are contracts of insurance within some abstract definition, but whether they are contracts of insurance for the purposes of the 1930 Act. If they are, then the benefit of the extended warranty contract itself is susceptible of being statutorily assigned under s 1(1). But the mischief which led to the passing of the 1930 Act, Page 26 of 28

27 as shown by the well-known decision in Re Harrington Motor Co Ltd, ex p Chaplin [1928] Ch 105, does not suggest that extended warranty contracts should themselves be subject to s 1(1). Nor, it appears to me, can it sensibly be said that the liability of the company to its customer under an extended warranty contract is a liability 'in the capacity of an insurer.' [31] Further, the consequences to a supplier, if the position were otherwise, which were not examined in argument, could be farreaching. Is the supplier required to comply with the statutory provisions regulating insurance business? If so, what are the consequences if it does not? For all these reasons, I would reject the second submission of counsel for the administrators in support of his contention that the [1930] Act has no application to this case. 52. PERG 6 correctly emphasises that in case of doubt, the purpose of FSMA 2000 will have significant weight: PERG 6.5.2G: PERG 6.5.3G: The FSA will interpret and apply the description in PERG 6.3.4G in the light of applicable legislation and common law, including case law. In particular, if the common law is unclear as to whether or not a particular contract is a contract of insurance, the FSA will interpret and apply the common law in the context of and in a way that is consistent with the purpose of the Act as expressed in the FSA's statutory objectives. 53. It is harder to evaluate what real weight the Court might put on the regulatory consequences of a finding that a contract is a contract of insurance. Sir Andrew Morritt V-C s comments in OT Computers are to balanced with his earlier comments in Fuji v Aetna, set out above: I would accept the submissions of counsel for Fuji that the scope of and regulatory consequences which might arise under the Insurance Companies Act 1982 and the Financial Services Act 1986 are not relevant to [the classification] issue. Page 27 of 28

28 54. However, more recent decisions of the Court of Appeal suggest that at least penal consequences under regulatory statutes will have weight: Financial Services Authority v Fradley and another [2005] EWCA Civ 1183 dealt with the question of whether a betting scheme was a collective investment scheme regulated under FSMA Arden LJ, giving the judgement of the Court, said: [32] This is one of the first occasions on which this court has had to consider s 235 of FSMA, that is, the meaning of 'collective investment scheme'. since contravention of the general prohibition in s 19 may result in the commission of criminal offences, s 235 must not be interpreted so as to include matters which are not fairly within it. Robert Purves 7 December 2012 Page 28 of 28