UK: Court Of Appeal Authoritatively Confirms Fraudulent Devices Rule

Last Updated: 21 October 2014
Article by Joe O'Keeffe and Elle Young

Versloot Dredging BV v HDI-Gerling & others, The DC Merwestone [2014] EWCA Civ 1349

On 16th October 2014, in a judgment of great significance to insurers in all classes of business, the Court of Appeal has authoritatively ruled in underwriters' favour as to the consequences of the use of a fraudulent device by an assured in connection with the presentation of an insurance claim.

The Court of Appeal has ruled that there is a "bright line rule" whereby an assured who employs a 'fraudulent device' forfeits his claim, despite the fact that the claim would otherwise have been recoverable under the policy.

The decision confirms (with one qualification) the correctness of Lord Justice Mance's (as he then was) obiter (non-binding) and "tentative" dicta in Agapitos v Agnew [2003] QB 556 (The Aegeon) which was to the effect that an assured who embellishes his claim with a lie will lose his claim (even if it would otherwise have been recoverable in full) if the lie directly relates to the claim and satisfies subjective and objective tests as to intention and materiality respectively.

By way of context, there is a long line of authority to the effect that an assured who fraudulently exaggerates his claim under an insurance policy forfeits any lesser claim which he could otherwise properly make (provided that the exaggerated element is not, taken in isolation, de minimis). This is referred to as the 'fraudulent claim rule'. The express public policy rationale of the rule is one of deterrence: an assured should not have a one way bet whereby he loses nothing if his fraud is detected. In The Aegeon Mance LJ held that a fraudulent device is a sub-species of a fraudulent claim, and that the fraudulent devices rule applies by extension to the fraudulent claim rule such that the assured who employs a fraudulent device will accordingly forfeit its claim.

The Aegeon has been applied and followed in a number of decisions of first instance courts and applied by the Privy Council and recognised by the Supreme Court, although neither The Aegeon itself nor the subsequent authorities were, strictly, binding precedent.

At first instance in the present case, The Aegeon was subjected to a searching and hostile critique by Popplewell J, but nonetheless applied. The Court of Appeal's decision handed down today authoritatively confirms the correctness of Mance LJ's dicta in The Aegeon.

First Instance Judgment

In January 2010, the DC Merwestone suffered a flooding incident. Quite remarkably, what should have been a minor and manageable ingress of water into the bow thruster space at the forward end of the vessel resulted in irreparable damage to the vessel's engine located at the aft end of the vessel.

The assured claimed on its Hull & Machinery policy in respect of the cost of replacing the damaged engine.

Popplewell J at first instance rejected underwriters' coverage defences but held that the assured had forfeit its otherwise valid and recoverable claim by its employment of a fraudulent device.

During the casualty investigation underwriters' solicitors sought the assured's explanation for the ingress, its spread from the bow thruster room to the engine room and the reason why crew were unable to control it using the vessel's pumps. The assured's General Manager responded in a letter which contained a representation that the crew had reported that they had heard a bilge alarm (which would have alerted the crew to the flooding) at noon on the day of the casualty but had failed to investigate the alarm on the basis that its sounding had been attributed to the rolling of the vessel. The representation was untrue in that the crew had never heard or reported a noon alarm and had never given an explanation for not investigating.

Popplewell J held that that representation as to the noon alarm was a reckless untruth. The General Manager had no basis to make the representation, having consciously decided not to ask the crew whether it was correct. It was held that the General Manager had not enquired of the crew because he did not want the absence of their confirmation to hinder him giving an explanation of the flooding that involved no fault on the part of the assured's shore-side management (which might have afforded underwriters a defence to the claim).

Having held that the representation had been made recklessly, the Judge found that the representation directly related to the claim; that it had been made by the General Manager with the subjective intention of improving the assured's prospects of payment or settlement; and that it satisfied the relatively low threshold materiality test tentatively suggested by Mance LJ in The Aegeon. Although The Aegeon was not strictly binding on the judge (Mance LJ's comments being obiter dicta), the Judge considered himself compelled to apply The Aegeon and ruled (with manifest regret) that the claim was forfeit by reason of the employment of a fraudulent device.

In light of his express misgivings as to the potentially disproportionate harshness that the fraudulent devices rule as articulated by Mance LJ in The Aegeon could visit on a fraudulent assured (ie forfeiture of an otherwise valid claim), Popplewell J granted the assured permission to appeal on various grounds.

The grounds of appeal which were of general significance were that (i) the fraudulent devices rule as tentatively articulated in The Aegeon was wrong as a matter of law; and (ii) in any event the rule should be struck down on the basis that it violates an assured's rights under Article 1 of the First Protocol to the European Convention on Human Rights (A1P1).

The Court of Appeal Judgment

The Court of Appeal unanimously rejected the assured's appeal.

Lord Justice Clarke gave the leading judgment, setting out "several powerful reasons" for answering in the affirmative the question as to whether the fraudulent devices rule as articulated in The Aegeon should be applied as a matter of binding law.

Those reasons included the facts that whilst not binding, the decision in The Aegeon was "authoritative"; it had been applied and followed and cited without disapproval in numerous cases including cases in the Supreme Court and Privy Council; and it was justified on the basis of the public policy imperative of deterring fraud in insurance claims.

Further, it was held that the extension of the fraudulent claim rule to fraudulent devices is consistent with and supported by the Law Commissions' view of the law and their proposals for law reform.

Clarke LJ recognised that the fraudulent devices rule could operate to produce harsh results in particular cases, however, he found that "the rule is only applicable in case of fraud, from which no insured should have any difficulty in abstaining".
In other words, the rule only visits harsh consequences on assureds who are fraudulent.

Despite confirming The Aegeon as good law, Clarke LJ left open the question as to the appropriate materiality test. Mance LJ suggested a test in The Aegeon on the basis that the lie told to embellish the claim must be one which "if believed would tend to yield a not insignificant improvement in the assured's prospects of success prior to any final determination of the parties' rights..." Clarke LJ questioned the adoption of this negative formulation and expressed a preference (without deciding the point) for a positive requirement that the fraudulent device should "objectively have tended to produce" a "significant improvement in the insured's prospects". Whether there is a real difference between a "significant improvement" and a "not insignificant improvement" will doubtless be a matter for debate in the future. It was held in the present case that the misrepresentation would have satisfied the test on either formulation.

As for the Human Rights Act argument, it was said by the assured that the fraudulent devices rule violates A1P1 which provides that "every natural or legal person is entitled to the peaceful enjoyment of his possessions" (a company being a "legal person" and an accrued right to indemnity under an insurance policy being a "possession"). Section 6 of the Human Rights Act 1998 makes it unlawful for a public authority, which includes a Court, to act in a way which is incompatible with A1P1.

It was agreed that forfeiture of an insurance claim is an "interference" with "possessions" that potentially engaged A1P1. The issue therefore was whether the interference was justifiable on the basis that it "pursue[s] a legitimate aim by means that are reasonably proportionate to the aim sought to be realised" (AXA General Insurance Ltd v HM Advocate [2002] 1 AC 868) and strikes "a fair balance ... between the demands of the general interest of the community and the requirements of the protection of the individual's fundamental rights" (Barnes v Eastenders Cash & Carry plc [2014] 2 WLR 1269).

In this respect, there was no real dispute that the fraudulent device rule has a legitimate public policy aim (deterrence of fraud) but the assured argued that in the absence of a case-by-case proportionality test the rule violated A1P1.

The Court of Appeal accepted underwriters' submission that the rule contains its own in-built proportionality test in the sense that the rule only applies to fraudulent devices that (i) directly relate to the claim; (ii) are intended by the assured to promote his prospect of success; and (iii) are, objectively assessed, capable of improving the assured's prospects of payment or settlement prior to final determination of the parties' rights.

Clarke LJ held that the critical question in terms of A1P1 was not whether the consequence of forfeiture in an individual case was proportionate to the fraud but whether a general rule that the use of a fraudulent device which fulfils the three criteria set out above forfeits the claim is, looking at the matter overall, a proportionate means of securing the aim of deterring fraud in relation to insurance claims. He answered that critical question in the affirmative noting that "once it is accepted that deterrence is a legitimate aim, the fact that forfeiture is a harsh, in some circumstances very harsh, sanction does not mean that it is disproportionate".

It was therefore held that the fraudulent device rule does not violate A1P1.

Comment

The judgment is of real significance to both marine and non-marine underwriters. It authoritatively establishes that an assured who uses a fraudulent device to promote an otherwise valid claim forfeits its claim.

It remains to be seen whether the assured will be given leave to appeal to the Supreme Court.

Joe O'Keeffe and Elle Young of Ince & Co acted for the successful underwriters in the First Instance and Court of Appeal proceedings. Faz Peermohamed and Paul Billowes of Ince & Co conducted the initial casualty investigation.

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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