Insurers – How to avoid your policy avoidance decision being overturned by the Court

In a decision handed down remotely on 21 April 2020, the High Court  has held that an Insurer must act fairly and rationally when exercising its discretion to avoid a policy subject to an Innocent Non-Disclosure (“IND”) clause. This is the first time that the High Court has ruled directly on such matters and the Court’s Judgment is required reading for Insurers to ensure that going forward they have the correct systems in place and that they exercise their discretion properly and so as to prevent intervention by the Courts.

Facts

The Claimant bridging finance lender brought an action under the Third Parties (Rights against Insurers) Act 1930 to recover an indemnity from the Insurer in respect of underlying judgments that it had obtained against the Insured surveyor arising out of eleven negligent property valuations.

Issues

The issues in dispute related to the Insurer’s attempted avoidance of the Insured’s professional indemnity policy for the 2013 and 2014 years (the “Policies”).

The Policies each contained an IND clause, which stated that:

“In the event of non-disclosure or misrepresentation of information to us, we will waive our rights to avoid this Insuring Clause provided that… (i) you are able to establish to our satisfaction that such non-disclosure or misrepresentation was innocent and free from any fraudulent conduct or intent to deceive.”

The Insurer sought to avoid the Policies on the basis that prior to their renewal, misrepresentations and non-disclosures had been made on behalf of the Insured in the insurance applications. The underlying facts were complex but in essence the Insurer’s position was that the Insured had historically carried out valuations for sub-prime commercial lenders but had (i) not disclosed this and (ii) indicated positively (despite obvious interest by the Insurer in such issues) that it had only valued commercial properties for “prime” UK clearing banks and building societies. The Insurer took the position that the alleged misrepresentations were neither innocent nor free from fraudulent conduct or intent to deceive.

High Court’s Decision

The Court concluded that material non-disclosures had been made by the Insured during the policy renewals but the process that the Insurer had adopted in order to reach its decision to avoid the Policies was flawed and the avoidance could not stand.

The Court determined that per the IND clause (i) the burden was on the Insured to prove an absence of fraudulent conduct and (ii) the ultimate decision maker in relation to whether the Insured had been fraudulent was the Insurer and not the Court. However, the Insurer’s exercise of the IND clause was qualified by a Braganza  duty. This duty was to the effect that an implied term was inserted limiting the manner in which the Insurer could exercise its discretion so that it was not open to the Insurer “…to make decisions that were arbitrary, capricious or irrational.” This is akin to the concept of “Wednesbury” reasonableness which the Court applies when judicially reviewing public authority decisions. It requires the correct questions to be asked and the correct matters to be taken into account in order to avoid a decision that no reasonable decision maker could have reached.

The implied Braganza duty allowed the Court to police the exercise of the Insurer’s rights to assess whether the outcome reached by the Insurer “…was open to a reasonable decision maker on the basis of the facts and matters such a decision maker was entitled to take into account in arriving at such a decision.”

The Court concluded that the Insurer had failed to comply with its duty to take into account only facts and matters relevant to the dispute and to exclude irrelevant considerations. In particular, the Insurer had failed to:

1. Start its thinking in the correct place, by recognising that it is more probable that a misrepresentation has been made innocently or negligently rather than dishonestly made; and
2. Appreciate that the conduct of the Insured was consistent with an honest mistake and a belief that the Insurer’s objection to sub-prime lenders only applied to residential property lenders and not to commercial property lenders.

As a result, the Court held that it could not safely conclude that the Insurer would have reached the same decision to avoid the Policies had their decision-making process not erred in this manner. The Court held that the flaws in the Insurer’s conduct permeated “… the whole of the decision making exercise…”.

Comment

The case outlines the decision making process the Court will expect where Insurers seek to avoid applying similar IND clauses. Although this is a case applying the pre-Insurance Act law, the authority applies equally to Insurance Act cases where similar IND language is used in a policy.

It is important to note that while the Court concluded in favour of the Claimant in this case and said that it could not safely conclude that the Insurer’s decision would have been the same if the decision making process had been undertaken properly, neither did the Court appear to entirely rule out the possibility that a “…defensible decision to avoid cover…” in the given circumstances could have been made by the Insurer – had the correct matters been taken into account in the decision making process.

Given the parallels drawn with Judicial Review, one might have expected the Court to send the matter back to the Insurer to make its decision again, this time taking into account the correct issues and disregarding the irrelevant. However, while the Judgement does not say so, we understand that the Court has simply ordered Judgment against the Insurer for the claimed sums, effectively holding the avoidance as invalid. We understand the Insurer may be appealing the matter to the Court of Appeal.

The following non-exhaustive best practice tips should help Insurers going forward when considering avoidance under similar IND clauses:

• The starting point should be to demonstrate that you understand the fact that it is more probable that a misrepresentation has been made innocently or negligently rather than dishonestly. Cogent evidence of dishonesty is required.
• Do not rely on pre-conceived conclusions as to the reasons for an Insured’s conduct. It is vital that you approach the decision making process from a neutral perspective, taking account of all of the evidence and material that is available to you as part of your analysis and that your file reflects this approach.
• Keep an internal record in which you can log the matters that you have / have not taken into account when reaching a decision as to whether to avoid the policy.
• Ensure that you update your Claims Handling Manual and internal training procedures to provide Claims Handlers with guidance and support in handling issues / disputes of this type and have a specific training session on the same.
• While a meeting with the Insured to hear their side of the story is not always required (and the Court in this case did not criticise the Insurer for not having held one), it is recommended as evidencing a balanced decision making process.

For further information please contact Stephen Reilly.