UK: Further Proposals For Reform From The Law Commissions

Last Updated: 20 September 2012
Article by Simon Konsta and James Roberts

The Law Commissions of England and Scotland have now published their long-awaited second consultation paper on proposed reform of the law relating to a business insured's duty of disclosure, as well as the law on insurance warranties.

We set out below the main proposals being advanced and their likely impact on insurers and policyholders.

1) The Business Insured's Duty of Disclosure

Many of the proposals set out in the consultation paper do not represent "new" law but, instead, seek to clarify the law of disclosure as it applies in a non-consumer context. The proposals apply to all business insurance, including reinsurance and the insurance of large risks. Rather than "protecting" business policyholders, the proposals are said to be intended to achieve "neutrality" between the parties.

The Law Commissions propose amending the relevant sections of the Marine Insurance Act 1906. To a large degree, the proposals are intended to codify principles which have already been developed by the courts. For example, legislation would be introduced to reflect the requirement that an insurer prove that, but for a certain misrepresentation, it would not have entered into the contract at all, or would have done so only on different terms. It is also suggested that legislation clarify that if a representation is one which the policyholder knew or ought to have known about, it must be true (otherwise, it must only be made in good faith).

Three proposed changes to the current law, though, are particularly note-worthy:

(a) A new system of proportionate remedies for breach of the duty of disclosure is suggested.

It will be recalled that the Consumer Insurance (Disclosure and Representations) Act received Royal Assent last year and is now expected to come into force in spring 2013. That Act establishes that the remedy for a breach in relation to consumer insurance will depend (broadly) on whether the insured has acted honestly and what steps the insurer would have taken before the policy was concluded had he known the true position. That test is largely replicated in the proposals for business insurance. Hence:

i. where the insurer would have declined the risk altogether, the policy can still be avoided (with a return of premium, although where a policyholder has acted deliberately or recklessly, the insurer need not return the premium)

ii. where the insurer would have accepted the risk but included a certain contractual term, the contract should be treated as if it included that term, and

iii. where the insurer would have charged a greater premium, the claim should be reduced proportionately

Crucially, though, insurers will be able to contract out of these remedies in the context of business insurance – provided that this is done through the use of clear and unambiguous language which is expressly brought to the attention of the policyholder before the contract is concluded. It might be thought that the ability to contract out could render this proposed change futile. However, the Law Commissions suggest that, outside of specialist insurance, parties would not routinely agree to avoidance in all cases. Even where the proportionate remedies would apply, though, it is worth noting that the proposed test is entirely subjective. This may serve to "water down" the effect of the proposals, since it will in practice be hard to disprove that a particular insurer would have viewed a certain breach of the disclosure obligation as so serious that he would not have written the risk at all.

(b) The Law Commissions have proposed clarification of what is meant by "knowledge" when applied to a business.

The Law Commissions have observed that larger businesses often experience greater problems with disclosure than small businesses, since multi-national businesses are now so complex that few can be sure they have assembled all the requisite information to give to insurers. Accordingly, it is proposed that there should be clarification of this issue.

In particular, "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. It would also encompass both actual knowledge and "blind eye" knowledge (ie where the relevant individuals deliberately avoid acquiring information because they would prefer not to know).

A corporation should also be under an obligation to make reasonable enquiries before placing insurance. These enquiries ought to be proportionate to both the type of insurance being purchased and the size, nature and complexity of the business itself. This may mean that larger businesses will not be able to rely on merely completing the proposal form (the Law Commissions have confirmed that they agree the duty to volunteer essential information remains for all types of business insurance). There would be no duty to disclose information which would not be revealed by reasonable enquiries (presently, the insured is under no duty to make reasonable enquiries, save where those enquiries are required in the ordinary course of business).

The Law Commissions have considered whether a special regime ought to apply to "micro-businesses" (ie companies with fewer than ten employees). Even though they recognised that it might be logical to afford such businesses the same protection as that given to consumers, they concluded that a separate regime would not be readily workable or justifiable.

(c) The duty of disclosure should also include information received or held by a broker in the course of acting for the policyholder.

The Law Commissions have dropped a suggestion that an insurer should be given a right of damages against brokers. However, they saw a need to clarify that a duty of disclosure includes information received or held by a broker in the course of acting for the policyholder. This includes producing, placing and intermediate brokers (and not just placing brokers). However, it does not include information given to the broker by other clients in relation to other insurers. The same actual knowledge/blind eye test as applies to policyholders would also apply to brokers.

If a broker is involved in helping the policyholder to carry out reasonable enquiries, the insurer should have a remedy against the policyholder if the broker fails to disclose information which it would have discovered by reasonable enquiries.

2) The Law of Warranties

The possibility of reforming the law of warranties has been mooted since the 1980s and the Law Commissions published a consultation paper in 2007 on this topic.

There are three proposals for reform in the consultation paper and they apply to both consumer and business insurance. It is envisaged that it will be possible to contract out of the reform for business insurance but not consumer insurance (but, again, clear and unambiguous exclusionary language will be required and it will have to be brought to the attention of the policyholder):

(a) abolishing basis of the contract clauses. Any clause which purports to give warranty status to answers on a proposal form would be of no effect. It will be necessary to expressly provide if a warranty is a warranty of past or present fact. However, the proposals do not go as far as the recommendation in 2007 that warranties of fact in a consumer policy should be made ineffective

(b) a breach of warranty would suspend the insurer's liability rather than discharge it, so that, if a breach is remedied before the loss, the insurer must pay the claim. However, the Law Commissions are also consulting on whether an insurer's right to cancel a contract (with a pro-rata return of premium) following a breach of warranty should be contractual rather than statutory and therefore governed by the terms of the contract, and (c) changing the law relating to warranties (or indeed any type of contract term) designed to reduce the risk of a particular type of loss. So, for example, the breach of a warranty to install a burglar alarm would suspend liability for loss caused by a burglar but not a flood. Similarly, where a term is included to reduce the risk of a loss at a particular time or in a particular location, in the event of a breach, liability would be suspended only in relation to losses at that time or at that location

The Law Commissions recommend that these proposals should apply equally to express warranties in marine insurance. The default regime for breach of warranty should also apply to reinsurance in the same way as it applies to direct insurance business (currently, if a policyholder breaches a warranty, the reinsurer may refuse to indemnify the insurer even if the insurer has chosen to condone the breach). However, reinsurers will be able to contract out of this reform.

The consultation period will close on 26 September 2012 and the Law Commissions have advised that they plan to complete their project (and produce a draft bill) by the end of 2013. Actual reform may therefore be several years off and it is possible that the provisions which are finally adopted by Parliament will differ to some degree from the Commissions current proposals.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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James Roberts
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