UK: Duty Of The Broker To Inform The Insured Of Its Disclosure Obligations

Last Updated: 1 June 2010
Article by Alexander Oddy

In the recent case of Nicholas G Jones v (1) Environcom Limited (2) Environcom England Limited and MS PLC t/a Miles Smith Insurance Brokers [2010] EWHC 759 (Comm) Mr Justice David Steel restated the broker's duty to inform its client of its disclosure obligations. He also considered the extent of the broker's obligation to elicit material information for disclosure.

Despite the broker's negligent failure to advise properly on the insured's disclosure obligations, the insured was left without recourse, since its mode of business operation made it uninsurable. The case is a stark illustration of how changing operational risks for insureds can present challenges in securing effective insurance cover.

Background

The Defendants ("Environcom") ran an electrical goods waste recycling plant.  Their operations involved extracting and destroying chemicals in refrigerators. Around 15% of the fridges Environcom processed were modern fridges containing pentane, a highly flammable substance.  Bolts had to be removed from the refrigerators as part of the recycling process.  This often required the use of plasma cutters, which operated at very high temperatures and melted through the metal bolts.  Plasma cutters increased the risk that hot metal and sparks might start a fire. 

Between May 2004 and May 2008, various Lloyd's syndicates ("Woodbrook"), provided insurance to Environcom, including cover for property damage and business interruption.  Environcom's insurance broker was MS PLC ("Miles Smith"). 

During that period, there were a number of fires at Environcom's plant.  Environcom submitted insurance claims in respect of two of the fires (in October 2005 and December 2006).  However, a number of smaller fires, some of which may have been attributable to the use of plasma cutters and/or the processing of pentane fridges, were not disclosed to Woodbrook.

In early May 2007, shortly before renewal, Woodbrook informed Miles Smith that they were unable to offer renewal terms to Environcom because of the adverse claims experience due to the two fires in 2005 and 2006.  Miles Smith eventually persuaded Woodbrook to offer renewal terms, although the cover was much more expensive than in previous years.  Woodbrook's offer was accepted by Environcom.

Several relatively minor fires occurred after renewal.  Then, on 16 September 2007, there was a major fire which destroyed all of Environcom's plant and machinery.  The facility had to be demolished.  The fire was ignited by a plasma cutter and fuelled by pentane. 

Woodbrook refused cover, claiming that they were entitled to avoid the policy on grounds of non-disclosure of Environcom's use of plasma cutters and the numerous small fires which had occurred at Environcom's plant. Woodbrook commenced proceedings seeking a declaration of non-liability.  Environcom counterclaimed for an indemnity under the policy.  Environcom joined Miles Smith as a third party alleging negligence in the broking of the policies.  Woodbrook and Environcom settled before trial, but the proceedings against Miles Smith continued.

The parties agreed that Environcom had failed to disclose the use of plasma cutters, the recurrent ignitions as a result of use of the plasma cutters, and several small fires.

Environcom alleged that Miles Smith was negligent in failing to advise Environcom of its disclosure obligations.  It also alleged that at the time of renewal in May 2007, Miles Smith failed to make the necessary inquiries which would have led to disclosure.

Miles Smith argued that it had discharged its duty to inform Environcom of its disclosure obligations and specific inquiries would not have elicited the material information regarding the plasma cutters and fires.  Even if proper disclosure had been given, either Environcom would not have been able to renew its insurance, or cover would only have been provided subject to conditions which would have prevented the fire from occurring.

Decision

Broker's duty

David Steel J began his analysis by affirming (by reference to ICOB 4) the usual position that a broker has a duty to:

  • advise their client of the duty to disclose all material circumstances (facts);
  • explain the consequences of failing to do so;
  • indicate the sort of matters which ought to be disclosed as being material or arguably material;
  • take reasonable care to elicit matters which ought to be disclosed but which the client might not think it necessary to mention.

The Judge emphasised that if a new person became responsible for insurance matters in the client's organisation (as was the case at Environcom), the broker had a duty to ensure that the new person had the requisite understanding of the duty of disclosure.

 The use of written advice

Miles Smith argued that it had fulfilled its duty by sending various documents to Environcom which explained its disclosure obligations.  Miles Smith relied on several documents, including a letter dated November 2004 enclosing a "Summary of Insurance", Miles Smith's revised terms of business dated January 2005, various invoices for premium and Proposal Forms.  All of these documents contained some advice on the insured's disclosure obligations.

However, David Steel J concluded that none of these documents was sufficient to satisfy Miles Smith's duty to Environcom because they failed to adequately explain the obligation to disclose material facts, the nature of material facts, and the consequences of failing to disclose material facts, nor did they assist in determining at what stage disclosure was required.

The Judge emphasised that brokers could not rely on standard documents alone:

"I am not persuaded that it is sufficient simply to rely upon written standard form explanations and warnings annexed to proposals or policy documents...The broker must satisfy himself that the position is in fact understood by his client and this will usually require a specific oral or written exchange on the topic, both at the time of the original placement and at renewal (particularly if a new person has become that client's representative)."

In summary, David Steel J concluded that Miles Smith had failed to give adequate advice to Environcom on its disclosure obligations.

 Duty to make inquiries

The Judge then went on to consider the broker's obligations to make inquiries of its client for the purposes of identifying material facts to be disclosed. 

David Steel J suggested that, if a broker has not discharged its duty to inform its client of its disclosure obligations, then a higher standard of care may apply:

"... where an inappropriate and incomplete explanation is afforded to the client as to his obligations, it follows that there is a higher standard of care on the part of the broker in eliciting arguably material information for disclosure."

However, the Judge rejected Environcom's contention that Miles Smith owed a duty to inquire about:

  • the use of plasma cutters – this inquiry was too specific or unique to expect a reasonable broker to have made them;
  • processes involving heat – this inquiry would not have revealed the use of plasma cutters;
  • hazardous processes – this inquiry would not have elicited an informative answer because Environcom did not regard plasma cutters as hazardous.

Nevertheless, Miles Smith should have advised Environcom that fires (whether significant or not) were disclosable and should have made inquiries regarding fires.  In so finding, he rejected Miles Smith's arguments that it was obvious to the individual at Environcom responsible for obtaining insurance for fire risks that fires were a material matter requiring disclosure.  If the person at Environcom responsible for insurance had been asked about fires however insignificant, he would have passed those inquiries on to Environcom's health and safety officer, who would have disclosed the fires and source of ignition.

David Steel J therefore concluded that Miles Smith had failed to take adequate steps to elicit information requiring disclosure.  If it had done so, the existence of regular small fires (and their association with the use of plasma cutters) would probably have been disclosed.

 Insurability

The Judge then addressed the question of whether, if Miles Smith had fulfilled its duties and proper disclosure had been given, Environcom would have been able to renew its insurance.

David Steel J concluded that:

  • Environcom had not established that there was a realistic chance of it taking the proposed risk reduction steps that would have been a precondition to cover, including the installation of a fire suppression system;
  • Even with risk reduction measures in place, there was no realistic chance that Woodbrook would have offered renewal terms;
  • There was even less chance of other underwriters providing cover, given the claims history and Woodbrook's refusal to renew (which would have to be disclosed);
  • Even if an offer of renewal had been made, the prospect of Environcom accepting what would have been fairly onerous terms of cover was remote; and
  • Even if cover was obtained, the insurer could have avoided the cover due to Environcom's failure to disclose that it was processing pentane fridges in breach of its Waste Management Licence.

Finally, even if cover was obtained, the Judge concluded that the preconditions to cover would probably have prevented the September 2007 fire and Environcom would not have had to claim under its insurance. Environcom had not pleaded that the fire was caused by Miles Smith's breach of duty.  However, if it had, David Steel J found that such loss was too remote and was not, therefore recoverable.

David Steel J therefore concluded that, despite Miles Smith's breach of duty, Environcom was not entitled to recover from its broker in respect of the September 2007 fire loss.

Comment

The decision is a stark reminder to insureds of the draconian nature of insurers' remedy for non-disclosure of a material fact: avoidance.  Perhaps more unsettling for insureds is the fact that, notwithstanding the negligence of the broker in failing to explain the duty of disclosure adequately or to ask sufficiently searching questions during successive renewals, the broker escaped liability and left the insured bearing the uninsured loss. 

At one level this might be explained away as an exceptional case because of the Court's finding that this was an uninsurable risk for a relatively specialised company seeking cover from a specialist section of the insurance market where only limited capacity existed.  It is rare that brokers succeed with a causation defence of this nature (i.e. their negligence did not cause the loss).  The broader point, however, is that the case demonstrates that there may well exist material facts to be disclosed by insureds which the brokers will not know nor which would be discovered even with an appropriate level of enquiry.  On the facts changes in the nature of the insured's business operation gave rise to fire risks that they perceived to be trivial and would not have explained to the broker even if asked.  For those buying insurance on behalf of insureds, therefore, the message is to consider the extent to which the operational risks are genuinely understood and can be conveyed to the brokers and in turn insurers to ensure that the insurance that is placed is unimpeachable. 

A practical lesson that also arises concerns the Judge's comments over changes in the personnel at the insured and the need for the broker to ensure that successive insurance buyers at their client were properly advised as to the duty of disclosure.  All insureds, whether with permanent risk management and insurance buying personnel or not, will no doubt wish to ensure that dialogue with brokers over disclosure obligations does not proceed on the assumption that these crucial matters do not need regular discussion and fresh attention at each renewal as a minimum (and of course at any mid-term events which revive the duty).

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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