The In-House Lawyer

Terminal traps in insurance contracts

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The terms of any insurance contract can be categorised as conditions, conditions precedent, warranties, or terms delimiting the risk. The status of conditions and warranties in mainstream contract law is reversed in insurance law. Breach:

  • of a condition sometimes gives rise to a right to terminate the contract if the breach is repudiatory and accepted as such, but more usually only to a remedy in damages;
  • of a warranty automatically terminates the contract from the date of breach unless waived.

Conditions precedent

A breach of a condition precedent is an altogether different and far more unpleasant proposition. A condition precedent:

  • is an express contractual term;
  • requires strict compliance; and
  • if breached, automatically discharges the insurer from liability for the claim to which the term relates (or more rarely results in the termination of the policy).

Properly drafted it should specify:

  • that the term is a condition precedent;
  • how it is to be discharged; and
  • the mishap that will befall the insured should they fail to comply.

What does it look like?

Many problems arise out of the difficulty in identifying a condition precedent. The fact that a term starts with the words, ‘it is a condition precedent to cover under this policy that… ’, is not a conclusive determination of whether it is or not.

The converse is equally true. The absence of the magic words of identification does not denude the clause of its Draconian quality as a condition precedent, provided that in their place the terminal consequences of non-compliance are spelled out in clear terms that brook no alternative interpretation. Any wording that clearly provides for an avoidance of the policy or a preclusion of liability in the absence of compliance will be a condition precedent. No specified form of words is necessary provided that the intention is clear and it is the insurer’s duty to make it clear if they intend to rely on it. Despite the fact that in many situations a term drafted as a blanket configuration of all terms as conditions precedent will not be upheld in whole or in part, because as a matter of construction some of the terms cannot be conditions precedent, some insurers continue to express all clauses collectively as conditions precedent. On the surface this might be perceived as being an unreasonable attempt by insurers to hold all the cards come the inevitable breach or dispute but, while it is distasteful on the one hand, it is merely the logical extension of the fact that the insurer could perfectly validly express each term individually to be a condition precedent. However achieved, the key for the insurer is to establish a conditional link between the obligation placed on the insured and the liability of the insurer.1 In a case that should worry insureds, Aspen Insurance UK Ltd & ors v Pectel Ltd [2008], policy condition 4(a) required the insured to give immediate written notice to its brokers of: ‘(i) any occurrence which may give rise to indemnity under this insurance.’ Condition 13 went on to state that:

‘The liability of underwriters shall be conditional on … the assured paying in full the premium demanded and observing the terms and conditions of this insurance.’

The claim was notified late to the insurer. The court held that the latter provision made it sufficiently clear that the parties intended there to be the necessary conditional link between the obligation to notify and the requirement of the insured strictly to comply with this obligation, because the insurers had a commercial imperative in investigating the claim at the earliest opportunity. The obligation to notify was therefore a condition precedent. While the commercial purpose of any notification clause cannot be denied, the clause in this case was relatively anodyne and the ease with which the notification clause was converted into a condition precedent was surprising to many observers. Hopefully its effect will be limited but currently it should not be ignored. However, the court interpreted condition 13 purposively to limit the effect of its breach, holding that the effect of condition 13 was not necessarily to require all conditions to be treated as conditions precedent. If they had been treated as such, insurers would be relieved of liability on a blanket basis following breach, so that breach of a notification provision in respect of one claim would allow the insurer to reject liability for another properly notified claim, which would not fulfil the parties’ commercial purpose and would be too Draconian a remedy.

Warranties

The benchmarks of a warranty include whether:

  • it goes to the root of the transaction;
  • it is descriptive of or bears materially on the risk of loss; and
  • damages would not be a satisfactory remedy for breach.2

The usual method by which insurers infuse a term with the status of a warranty is to obtain a signed declaration on the proposal form to the effect that the information contained in the proposal is warranted correct. This deletes any requirement of materiality or reliance by the insurer on the truth of the representation, since s33(3) of the Marine Insurance Act 1906 states that strict compliance with every warranty is necessary to render the insurer liable. Thus any breach of warranty entitles the insurer to refute liability, even though the breach is immaterial to and unconnected with the loss.

A warranty usually confirms that:

  • a state of affairs exists;
  • that it will continue to exist;
  • that it will exist in the future; or
  • the converse, ie that something does not exist.

Problems arise where the warranty is phrased so as to be capable of indicating an element of futurity, but without any element of certainty. These two types of warranty can also be subdivided into warranties of fact and warranties of opinion. Any breach of a warranty of fact is capable of determining the insurance, even though the insured was not at fault or even aware of the breach. A warranty of opinion may prove to be incorrect, but produces no adverse consequence for the insured if it was honestly held. The distinction is again fine, which allows the court some latitude in its decisions. The court may interpret apparently subjective answers that depend on the opinion of the insured not as warranties of opinion but as statements of fact, or refuse to accept subjective statements that could simply not be justified on the facts (which in reality imposes an objective standard). In Gerling – Konzern General Insurance Co v Polygram Holdings and Metropolitan Entertainment Inc [1998], the information subjectively warranted (ie to the standard of the best of the warrantor’s knowledge and belief) as to Grateful Dead guitarist Jerry Garcia’s good health had not been checked, and even if it had been checked it was still not credible given what the warrantors knew of Garcia’s habits. The warranty had therefore been broken. Some statements carry an implied representation that they are made on reasonable grounds.

Neither foul condition nor fishy warranty

The courts have expressed their dislike of the rule that a warranty must be strictly satisfied, particularly where the warranty broken is immaterial to the loss that occurred, and have sometimes construed potential warranties as clauses describing or delimiting the risk or as suspensory conditions, which have the effect of removing the insurer from liability while the term is not complied with, rather than enabling it to terminate the contract.

courts’ treatment of their biggest customer

Two aspects of the legal system have started to ameliorate the insured’s position in recent years as regards conditions and warranties. The first is the natural inclination of the courts to find against insurers, who should have the inclination and resources to clarify their wordings. Thus: ‘If necessary, in case of doubt, one should construe an insurance policy in favour of the insured.’ Similarly,

‘It is more important to reinforce the message that insureds are entitled to clear wordings and to the benefit of any ambiguity, than to force the present particular policy wording (and probably other policy wordings in future) into an artificial mould created by legal authority. If any insurer does not like our decision, it can for the future formulate its policies differently, provided that it makes its intention clear.’4

Judicial assistance

The other is that until the late 1990s the fundamental principle of contractual interpretation was that it was an exercise in ascertaining ‘the intentions of the parties’ from ‘the natural and ordinary meaning of the language’ used, ie ‘what is the meaning of what the parties have said?’, not ‘what did the parties mean to say?’5 This formal approach did not allow its users to stray outside the four corners of the contract, paying strict attention to the parol evidence rule (in the absence of an appropriate exclusion). After 1998 the courts have manipulated the meaning of contractual language where they felt it necessary to reflect the commercial object or purpose of the contract (the purposive approach). The courts now view the interpretation of a document as the ascertainment of the meaning that the document would convey to a reasonable person having all the background knowledge that would have reasonably been available to the parties in the situation in which they were at the time of the contract. (However, is it worth noting that although some judicial squaring of the circle is permissible where appropriate, the court is not entitled to redraft a contract solely to achieve what it considers to be a reasonable result.6)

This approach can be clearly demonstrated by Newfoundland Explorer (GE Frankona Reinsurance Ltd v CMM Trust No 1400the ‘Newfoundland Explorer’ [2006]), in which an express term – ‘warranted vessel fully crewed at all times’ – appeared to be a warranty that obliged the insured to keep at least one crew member on board the vessel 24 hours a day. The context was critical to the construction of this term. A vessel undertaking an ocean voyage would have different crewing requirements to those of a vessel laid up in harbour. There would have to be a minimum of one crew member on board the vessel to satisfy the requirement of being fully crewed, but the other half of the clause – ‘at all times’ – also needed to be read in context. Thus an emergency, which might necessitate the evacuation of the vessel and therefore leave it devoid of crew, would not be a breach of warranty. Certain crew duties that could only be performed ashore would mean that a crew absence during the performance of such duties would not be a breach of the warranty. Thus the absence of crew on the vessel at a particular time would not necessarily be a breach of warranty.

While the purposive approach to construction is now firmly entrenched, it still operates within a framework of generic rules that have been established over several centuries. Although the modern approach of construction uses broad rules in keeping with its holistic approach to its dissection of a word or phrase in its context, the courts continue to use these rules, partly to provide a smoother way to what it believes is the ‘fair’ result, without redrafting the contract. They also apply because they reflect common sense. The fact is, however, that these rules are presumptions and, as such, act only as guidelines in the divination of the parties’ intentions. The rules can be contradictory and are often pushed aside by the courts when it suits. The two most commonly used are the contra proferentem rule and the eiusdem generis rule; another prime candidate, the parol evidence rule is more observed in the breach than the observance.

Contra proferentem

The contra proferentem rule, in relation to ambiguities, is one of the better known rules of construction, perhaps ironically given that it is generally only utilised by judges when other methods of construction fail. It is, however, used more often in insurance disputes than commercial disputes owing to the apparent imbalance of bargaining power between insurer and insured, and to continue teaching insurers the benefits of clear drafting. In essence it is that the wording in a contract is to be construed against the party seeking to rely on it and against the party who proposed it. The courts usually leap at the chance to use it against an insurer who has failed to express themselves clearly. Thus in Pratt v Aigaion Insurance Co SA, the ‘Resolute’ [2008]), the policy stated:

‘Warranted owner and/or owner’s experienced skipper on board and in charge at all times and one experienced crew member.’

After returning to port from a day’s fishing, the vessel caught fire when no-one was aboard.

The Court of Appeal held that the primary purpose of the warranty was to protect the vessel against navigational hazards as underlined by the reference to ‘one experienced crew member’. The clause should be construed contra proferentem against the insurer, and if the insurer wanted the owner or skipper on board whenever the generator was left running, it should have clearly said so. In reality the parties could not have contemplated that the skipper would be required to put out a fire. The purpose of the warranty was to protect the vessel in circumstances where the skipper would be needed if something went wrong. The insured was therefore not in breach.

Eiusdem generis

Finally, the eiusdem generis rule states that where one or more words exhibits a common or dominant feature, or a linking characteristic that constitutes them a genus, any following words of a more general nature will be construed as being limited to that genus. This is a useful rule for the courts when construing exclusions in insurance contracts. Thus in Tektrol Ltd v International Insurance Company of Hanover Ltd [2004] the list of exclusions read:

‘Erasure loss distortion or corruption of information on computer systems or other records programmes or software caused deliberately by rioters strikers locked-out workers persons taking part in labour disturbances or civil commotion or malicious person.’

The court took the view that the draftsperson was intending to cover acts aimed specifically at the insured’s computers and committed near the insured’s premises, rather than a computer hacker who targeted generally and indiscriminately from a remote location. While the author of the virus initiating the loss of information was a ‘malicious person’, the clause does not extend to interferences by such people that are not directed at the computer systems used by the insured at the premises. If the insurer wished to exclude all damage caused, however indirectly, by a computer hacker they needed to place that exclusion in a separate clause, and not refer to malicious persons in the same terms as rioters or locked-out workers.

result

The courts do therefore take all steps that they can to achieve what they consider a fair result, but there is a limit to their abilities to manipulate the wording. Insureds would be well advised to review their insurance policies carefully, and take every step to identify and comply with conditions precedent and warranties. Brokers would also be well advised to practise identifying the different terms at 25 paces, in the light of their obligation to advise their client of any onerous or unusual terms. If involved in drafting the policy wording brokers should exclude conditions precedent and warranties wherever possible, and where not possible identify them with sufficient precision to avoid later confusion and dispute. The broker is expected to have some understanding of the legal issues involved, and any loss that flows from that negligence and is not too remote will be recoverable by the insured.7

By Jeremy Hill, partner, and Christopher Henley, international counsel, Debevoise & Plimpton LLP.

E-mail: jhill@debevoise.com; chenley@debevoise.com.

notes
  1. Friends Provident Life & Pensions Ltd v Sirius International Insurance [2005] EWCA Civ 601.
  2. HIH Casualty & General Insurance Ltd v New Hampshire Insurance Company & ors [2001] EWCA Civ 735.
  3. Hawley v Luminar Leisure Ltd & ors [2006] EWCA Civ 18.
  4. Dodson v Peter H Dodson Insurance Services [2001] EWCA Civ 320.
  5. L Schuler AG v Wickman Machine Tool Ltd [1973] UKHL 2.
  6. Homburg Houtimport BV v Agrosin Private Ltd (The Starsin) [2001] EWCA Civ 56.
  7. Ramco v Weller Russell and Laws Insurance Brokers [2006] EWCA Civ 889.
 

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