i-law

Law of Insurance Warranties, The

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CHAPTER 5

The Law Commission’s previous reports and recommendations on warranties

The Commission’s 1980 report

5.1 As long ago as 1957 the Law Commission recommended the abolition of warranties,1 but this recommendation was never pursued. In 1980 the Commission observed ‘it seemed quite wrong that an insurer should be entitled to demand strict compliance with a warranty which was immaterial to the risk.’2 The Law Commission’s 1980 report, Insurance Law: Non-Disclosure and Breach of Warranty, adopted a complex approach under which a breach of warranty could not be relied upon if, inter alia, it could not have increased the risk that the event which gave rise to the claim would occur in the way that it did in fact occur.3 The Commission recommended that basis clauses should be abolished and that insurers be required to provide policyholders with written documents containing any warranties. The Commission observed that its proposals would not prevent specific facts from constituting a warranty, provided this was incorporated into the policy itself.4 Clause 8(2) of the draft Bill accompanying the Commission’s report stated that an insurer would not be entitled to rely on a breach of warranty unless the insured was supplied with ‘a written statement of the provision which constitutes the warranty.’ This statement was to be supplied to the insured at or before the time the contract was entered into, or ‘as soon thereafter as was practical in the circumstances of the case.’ The Commission’s subsequent reports acknowledged that the problem with clause 8(2) was that an insurer could comply with it even if it buried the warranty in a mass of small print.5 5.2 Although in its initial consultation paper, the Commission proposed that for a warranty to be effective, an insurer would have to show it was material to the risk, in its final report the Commission withdrew this requirement. Instead, it proposed that a warranty should be assumed to be material, unless the insured showed that it would not have influenced a prudent underwriter. The Commission’s draft Bill envisaged that an insured would be able to challenge an insurer’s decision not to indemnify for breach of warranty on three grounds:
  • (1) The warranty did not relate to a matter which was material;6
  • (2) The warranty was intended to safeguard against a risk of a description ‘which does not include the event which gave rise to the claim’;7 or

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    (3) The breach of warranty could not have increased the risk that the event which gave rise to the claim would occur in the way in which it did in fact occur.8
5.3 A key criticism of the Commission’s proposals was that the defence available to a policyholder only applied if the term was classified as a warranty. Birds and Hird suggested that as a result, the Commission’s recommendations might have been easily evaded by insurers resorting to the use of other conditions and exceptions.9 The Commission later acknowledged the flaw in its 1980 proposals, commenting in its subsequent Issues Paper on Warranties that ‘the same answer should apply to both warranties and descriptions of the risk. It should not depend on formalities about how the term has been written.’10 This is clearly sensible; as will be discussed later, for reform of this area of the law to be effective it is essential that it should not be confined solely to warranties.

Law Commission Insurance contract law issues paper 2 warranties, November 2006

5.4 The Law Commission returned to the subject of insurance warranties in 2006. At this juncture the Commission indicated that in its view the principal problems with the law of warranties were that insurers could refuse to pay a claim for actions or omissions that:
  • (i) Were immaterial to the risk;
  • (ii) Were only relevant to other risks;
  • (iii) Had already been remedied.11
5.5 The Commission observed that these problems were exacerbated by the ability to use basis clauses. However, in the Commission’s view, ‘The greatest and most obvious problem with the law on warranties is that it permits the insurer to escape liability for technical breaches that have nothing to do with the loss in question.’12 The Commission recommended that all express warranties should be in writing and included or referred to in the main contract document. The Commission was of the view that the law should afford policyholders some protection against claims being denied for reasons unconnected with the loss. The Commission concluded that a policyholder should be entitled to be paid a claim if he could prove, on the balance of probability, that the event or circumstances constituting the breach of warranty did not contribute to the loss:13 a clear causal linkage test. Further, the Commission tentatively proposed that the law should provide that if a breach contributed to only part of a loss, the insurer may not refuse to pay the part not related to the breach.14 Moving away from their previous approach, the Commission also tentatively recommended that, as in New Zealand, the recommended approach should extend beyond warranties and apply to all terms that enabled the insurer to refuse to pay a claim for events

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or circumstances that add to the risk of loss.15 The Commission acknowledged that if the reform were confined to warranties, it would simply encourage insurers to draft around the constraint. 5.6 In order to overcome their concerns regarding the potential for expanding the scope of the cover agreed between the parties to the prejudice of the insurer, the Commission proposed that the causal connection test should not apply where the insurance related to one purpose, activity or place, and the loss arose from an entirely different purpose or activity or in another place.16 The approach recommended by the Commission was that a court would need to ask whether the difference in use was such that a reasonable insured could have expected the loss to be covered and the objective should be to distinguish between occasional and regular misuse. In order to apply such an approach, the courts would need to assess what it was reasonable for the insured to expect.17 The Commission recommended that its proposed causal connection test should also apply to marine insurance18 and that it should apply equally to both express and implied warranties.19 5.7 While in 1980 the Law Commission recommended against extending the reforms to reinsurance contracts generally, in its 2006 report, it proposed to reverse its position such that its recommended reforms would apply to the re-insurance market.20 Importantly the Commission also indicated that it was tentatively in favour of granting a right of termination to the insurer where the insured had breached a warranty.21

Law Commission Consultation Paper No. 182 Insurance Contract Law: misrepresentation, non-disclosure and breach of warranty by the insured, November 2007

5.8 The Commission observed that the existing law on warranties ‘defies logic and normal expectations, is inconsistent with good practice as recognised by the industry’s own Statements of Practice and risks bringing the UK insurance industry into disrepute.’22 5.9 The Commission reiterated its principal concerns regarding the existing law on warranties.23 Crucially however on this occasion the Commission’s proposals sought to distinguish between current fact warranties and future conduct warranties.

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 5.10 The key elements of the Commission’s 2007 proposals in respect of business insurance were as follows:
  • (1) In the absence of an agreement to the contrary, a specific fact warranty would entitle the insurer to refuse the claim following a breach of the warranty, provided that:
    • (a) the breach of warranty was material. For example, the insurer could not refuse a claim where the breach related to a failure to disclose a minor conviction (such as speeding) that would not have influenced the insurer’s decision to provide cover;
    • (b) the breach had some connection to the loss. For example, a manager’s conviction for dangerous driving would be unconnected to a flood damage claim.24
  • (2) Where a warranty concerned future conduct:
    • (a) It should be set out in writing.25
    • (b) A business should be entitled to be paid a claim if it could prove on the balance of probabilities that the event or circumstances constituting the breach did not contribute to the loss.26 This would be a default rule and amounted to a causal linkage test. The parties could agree other consequences if they wished (subject to controls on standard term contracts).27 The Commission’s report left it unclear whether (as the burden of proving a breach was not causative was on the assured) the insurer would be ‘off risk’ until the insured had satisfied the burden of proof? If so, in this author’s view, this would surely have been unreasonable.
    • (c) Proportionality would apply: if the insured could prove that a breach contributed only to part of the loss, the insurer would not be able to refuse to pay for that element of the loss that was unrelated to the breach.28
    • (d) A breach of warranty would not automatically discharge the insurer from liability, but would instead give the insurer the right to terminate cover for the future,29 but (unless otherwise agreed) only if the breach had sufficiently serious consequences to justify termination under the general law of contract.30 The Commission further recommended that if the

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      insurer chose to terminate in such circumstances, the insured should cease to be liable for any future premiums, as yet unpaid.31
  • (3) Where the parties contracted on the insurer’s written standard terms of business, the insurer should not be permitted to rely on a warranty, exception or definition of the risk if this would render the cover substantially different from that which the insured reasonably expected.32 The Commission explained: ‘The idea was that it would catch situations where, for example, a clause was put into the small print of a contract with a small business, saying that the consequence of all misrepresentations was avoidance, no matter whether they were material or honest.’33 The Commission saw three main arguments in favour of its reasonable expectations proposals;34
    • (i) The protection only applied to standard policy terms. It did not interfere with the freedom of large businesses to negotiate contracts on an individual basis.
    • (ii) It applied to any term that defined cover in a way that policyholders would not reasonably expect, whether it was a warranty, a condition precedent to liability or to cover, an exception, or a narrow definition of the risk.35
    • (iii) The proposal would apply only if the effect of the term were to render the cover substantially different from what the insured reasonably expected. The objective was to provide a strong incentive to insurers to re-write their contractual documents in a way that their policyholders could understand.
5.11 The Commission rejected the argument that a harsh warranties regime was necessary as a protection against fraud on the grounds that the use of technical defences was counter-productive and likely to bring both the law and the insurance industry into disrepute.36 The Commission identified three reasons to reform business insurance law: to protect businesses that were not expert in insurance; to provide a default regime that corresponded to legitimate expectations; and to ensure that UK insurance law remained competitive with that of other jurisdictions.37 5.12 The Commission also observed that it was unfortunate that the insured might simply not realise that the policy imposed a warranty obligation on him. Contrary to the position set out in their second Issues Paper, the Commission recommended that a causal connection test

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should be confined to warranties in the narrow sense.38 It seems the Commission reached this conclusion on the grounds that their original proposal would be too complex and would need several exceptions to cover: the Commission felt the causal connection test should not, for example, apply to terms which limited the age of a driver or the geographical coverage of the policy.39 The Commission re-affirmed its belief that insurers should not be entitled to rely on a breach of warranty unless the insured was supplied with a written statement of the warranty either before the contract was made, or as soon as possible thereafter.40 As will be argued in more detail later, this author proposes that, for it to be properly comprehensive, any reform of the law in this area must apply to all clauses that purport to provide the insurer with a right to avoid liability. It will be demonstrated that the issue of whether proposals for reform cover exclusion clauses, or are able to impact on questions of scope are central to the effectiveness or otherwise of any attempt to overhaul the law.41 5.13 The Commission indicated that in relation to warranties of fact, it did not think that it accorded with the expectation of any class of insured that the insurer should be discharged by an immaterial breach of warranty, or a breach that had been cured before any claim arose.42 Nor in the Commission’s view would an insured reasonably expect a claim to be rejected on the grounds of a breach of warranty of fact that had no connection to the loss.43 Crucially the Commission felt that it was not sufficient to leave it to the courts to construe a term in a fashion that gave it an equitable meaning. Furthermore, the Commission concluded that the UK was out of touch with global developments in this regard and that the UK concept of warranties no longer accorded with international conceptions of fairness.44 The Commission was concerned that this could lead prospective insureds to reject the UK market in favour of jurisdictions that were less harsh, or at least that required the position to be made more transparent. 5.14 The Commission was initially attracted to the New Zealand approach to the reform of warranties,45 but backed away from this position in the light of concerns from consultees. On the other hand, the Commission felt (perhaps surprisingly: see ) that the Australian approach was too generous to the insured.46 The Commission suggested that an

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insurer should be entitled to reject a claim if the breach had been a contributor to the cause of loss, albeit not the dominant cause. 5.15 Importantly the Commission intended that its proposed reasonable expectations approach should be an alternate to a wide causal connections test.47 In the Commission’s view, the law should ‘give potential policyholders confidence in the insurance by ensuring that it meets their reasonable expectations, while protecting the legitimate interests of insurers and not imposing undue costs or unnecessary restrictions’; further it should also be coherent, clear and readily understandable.48 The Commission suggested that, as it stood, ‘the law imposes a default regime that undercuts, rather than supports, accepted market practice. In so doing, it risks defeating the reasonable expectations of the insured.’49 5.16 It seems that under the Commission’s proposals the relevant consideration would be whether the assured appreciated the existence of the term before entering into the contract. In this context a significant factor would be whether the insurer had done enough to bring the relevant clause and its impact to the assured’s attention. If the assured was aware of a provision, a court would not be able to declare a provision invalid because the assured lacked the negotiating power to resist it.50 One obvious definitional question likely to arise would be what constituted ‘standard terms’: in some cases this would be clear, but at what stage in a negotiation would ‘standard’ become ‘non-standard’? The Commission proposed that the test would look only at procedural issues: did the insured appreciate the existence of the term, or did it undermine its reasonable expectation? If the insurer showed that the insured knew about the term and its implications before entering the contract, the term would stand, even if the insured only agreed to the term because it had no alternative.51 5.17 The Commission proposed that its recommendations in relation to warranties should apply equally to marine insurance as to other forms of insurance52 and that the causal connection test should apply to implied warranties. Interestingly, the Commission suggested that the courts had tended to construe warranties more strictly in marine cases than in other forms of insurance.53 Under the Commission’s proposals, in a voyage policy, the insured would only be paid if it could show, on the balance of probabilities, that the breach did not contribute to the loss.54 Under the Commission’s proposals for time policies, the insurer would have to prove that the breach was a real or dominant cause of the loss. The Commission suggested that if an insured could prevent the ship from being

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overloaded and failed to do so, it was possible that this might constitute a breach of the implied warranty that ‘the adventure shall be carried out in a lawful manner’ under s41 of the MIA. Under the Commission’s proposals it would be open to the insured to argue that the overloading was not intended at the outset, but was only a subsequent illegality. If the insured could prove that the overloading did not contribute to the loss, the insurer would remain liable.55 Although the Commission indicated that a number of representations had been made to them suggesting that implied warranties should be abolished,56 (as had been recommended (albeit not implemented) in Australia57), it stopped short of making such a recommendation. 5.18 Confusingly, the Commission’s recommendations could be interpreted as proposing an end to implied warranties, as under the Commission’s proposals, in order to defeat a claim on a policy, the warranty would have to be set out in writing in the main contract document or some other document at or before the time the contract was made or as soon as possible thereafter.58 However the Commission did not make such an explicit recommendation and it is probable that no such implication was intended. The Commission doubted the merit of retaining the implied voyage provisions set out in s43–46 of the MIA, but if they were retained, recommended that they should be subject to a causal linkage test as recommended elsewhere.59 5.19 Subsequently the Chairman of the Law Commission, Lord Hertzell, indicated that while consultees of the Commission’s proposals had expressed concern about the detail of the proposals, most supported a requirement for causal connection in order for the insurer to have a remedy.60 The Commission noted that the need for reform had been endorsed by the British Insurance Law Association.61 In the past the Association of British Insurers and its predecessor had argued that any changes were best dealt with as a matter of self-regulation or ombudsman discretion, rather than by a change in the law itself.

Criticism of the reasonable expectations approach

5.20 Although the distinction made by the Commission between current fact warranties and future conduct warranties received much adverse comment (which in this author’s view was in the main justifiable), the most controversial aspect of the Commission’s proposals were those elements relating to the insured’s ‘reasonable expectations.’ These came in for

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considerable criticism, much of which, it is suggested, had some merit. Bennett argued that businesses would prefer a clear rule that might operate harshly against their interests in particular circumstances, rather than an unclear rule designed to produce fair and equitable results, but which might require a lengthy and costly process to apply.62 Soyer had sympathy with arguments suggesting that the reasonable expectations approach was inherently vague and not appropriate to commercial insurance; he suggested that commercial insurers would seek to draft around it and pass the cost of doing so on to insured’s.63 He urged the Law Commission to re-consider. Rather than applying the reasonable expectations test to SMEs, Soyer suggested it might be better to treat SMEs as if they were consumers; although this could lead to definitional issues in terms of what constituted an SME, he argued that was preferable to the uncertainty of the reasonable expectations approach.64 However, notwithstanding his reservations regarding the Commission’s proposals in relation to ‘reasonable expectations,’ Soyer saw the Commission’s recommendations as a step in the right direction.65 Merkin observed that the meaning of the reasonable expectations test would remain unclear until tested by courts.66 Aikens was sceptical that it was a good argument to suggest that, because one party did not understand the law or its effect, the effect should therefore be changed in the hope that in the future that party would understand the law and that it would therefore meet their expectations. He suggested that it was more likely that the aggrieved party would continue to argue that the law did not meet their expectations. As a result, such an approach was likely to result in a slippery slope that tilted the playing field dramatically in favour of one party. He argued it was up to business parties to make themselves aware of the consequences of their actions.67 Aikens further suggested that there was some danger of parties’ freedom to contract being constrained in circumstances where standard terms used provisions other than a standard default regime and the assured argued that the outcome failed to match its reasonable expectations.68 This could be exacerbated by uncertainty over the definition of reasonable expectations. It did not follow in Aiken’s view that the law was ‘wrong and unjust,’69 simply because it did not meet with the assured’s reasonable expectations.70 In Aiken’s view a better solution would be for warranties to be

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specific, specifically agreed and, rather than appearing in standard terms, to be included in a separate document.71 5.21 In the round, the reasonable expectations elements of the Commission’s proposals raised too many issues and uncertainties and did not represent a robust approach to reforming the law of insurance warranties. An approach rooted in causal connection is, in this author’s view, to be preferred. What was welcome however was the Commission’s recommendation that a breach of warranty or other term should give the insurer the right to terminate the contract (rather than automatically discharging it from liability), provided (unless otherwise agreed) the breach was sufficiently serious to justify termination under the general law of contract. It will be argued that a right to terminate has a key role to play in the reform of the law in this area.72 Finally this author rejects the Commission’s proposal that a causal connection test should be confined only to breaches of warranties.

Law Commission Consultation Paper No. 204 Insurance Contract Law: the business insured’s duty of disclosure and the law of warranties, a joint consultation paper, June 2012

5.22 No progress was made on the Commission’s 2007 proposals and the Commission again returned to the subject in 2012. 5.23 The Commission acknowledged that many thought that the Commission’s 2007 proposals were too complicated, particularly in their distinction between current fact warranties and future conduct warranties. It also acknowledged that concern had been expressed about causation proposals and its proposed approach based on the insured’s reasonable expectations. 5.24 Echoing its earlier reports, the Commission identified four main problems with the existing law on warranties:
  • (i) Under section 33(3) of the 1906 Act, a warranty ‘must be exactly complied with, whether it be material to the risk or not.’ This meant that an insurer could refuse a claim as a result of a trivial mistake that had no bearing on the risk.
  • (ii) Under section 34(2), once a warranty had been broken, the policyholder could not use the defence that the breach had been remedied.
  • (iii) The breach of warranty discharged the insurer from all liability under the contract, not just for liability for the type of risk in question.
  • (iv) A statement could be converted into a warranty using obscure words that most policyholders did not understand.
5.25 The Commission argued that the result was that the existing law brought ‘the law in the UK into disrepute in the international market place.’73 As a consequence, outcomes lacked ‘logical reason’ and could not be explained in terms of either legal fairness or

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economic efficiency.74 Attempts by the courts to ameliorate the situation had introduced inconsistency and uncertainty.75 5.26 The Commission’s consultations did however demonstrate widespread support for reform.76 The Forum of Insurance Lawyers concluded that reform was ‘long overdue,’ while the Bar Council observed that reform ‘would be in keeping with most people’s sense of justice.’ Although many insurers welcomed the prospect of reform, the Association of British Insurers felt that the existing regime ‘works well for consumers and the industry,’ while for business customers ‘the guiding principle should be freedom to contract.’ Nevertheless, representations from industry made it clear that commercial buyers of insurance were strongly in favour of reform.77 A report from Mactavish suggested that mid-sized firms, turning over between £50 million and £5 billion, were particularly vulnerable78 to adverse outcomes under the existing law. 5.27 Submissions to the Commission included criticisms of the Commission’s earlier proposals for a causal connection test: that it would be difficult to apply in practice; that it would lead to an increase in costs; that it was not appropriate for all warranties; and it might increase moral hazard.79 Some suggested that there would be difficulties in applying the test where the breach increased the risk, or the loss incurred, but could not be shown to have directly caused either.80 Nevertheless, the Commission acknowledged that the causal link approach did receive wide-ranging support from both legal practitioners, and representatives of both insurers and insureds. 5.28 The Commission accepted that its proposals had gone too far and dropped the reasonable expectations element of their 2007 recommendations. The Commission also observed that the causal connection test was unsuited to many terms, and that it would be unduly confusing to apply the test to warranties and not to suspensive conditions.81 The Commission retained its view that its proposals should represent a default position for business insurance: business parties should be free to contract out, provided that both sides understood and agreed to a term.82 5.29 The key elements of the Commission’s revised proposals were as follows83:
  • (i) Abolish basis clauses;
  • (ii) A breach of a warranty should trigger suspension of the insurer’s liability for the duration of the breach. The insurer’s liability would be restored once the breach was cured;
  • (iii) For any term (not just warranties) designed to reduce the risk of a particular type of loss, a breach of that term should only suspend liability in respect of that type of loss. Thus, according to the Commission, a requirement to install a mortice lock

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    would suspend liability for theft loss, but not for fire loss. The same approach would apply where a term was designed to reduce the risk of loss at a particular time or at a particular location.
5.30 Reversing the position it took in 2007, the Commission, while continuing to support a right to terminate, felt that this was best left to the terms of the contract.84 While being of the view that business parties should be free to contract out of its proposals, the Commission recommended that any variation should be spelled out in clear and unambiguous terms, and specifically brought to the attention of the insured before the contract was formed.85 Unlike the position it had previously adopted, the Commission decided against recommending that warranties should always be in writing (although in practice business insurers do put warranties in writing). 5.31 The Commission recommended that its proposals apply to marine insurance, as well as to other forms of commercial insurance. The Commission suggested that the distinction between marine and other forms of insurance was unhelpful and had caused particular definitional problems in Australia.86 However in the light of submissions from insurers recommending the maintenance of the status quo, the Commission recommended the retention of implied warranties.87 Further the Commission recommended that the consequences of breach of an implied warranty should be consistent with breach of an express warranty and should thus suspend liability.88 The Commission recommended that the default regime for breach of warranty should apply to reinsurance in the same way as it applied to direct business insurance. 5.32 In seeking to illustrate the application of its proposals, the Commission suggested that in Forsikringsaktieselskapet Vesta v Butcher89 a warranty that the insured should keep a 24-hour watch at the farm would be interpreted as being aimed at the particular risk of loss through theft or vandalism.90 As a result, the Commission argued that liability would be suspended only in respect of theft or vandalism and that accordingly the insurer would be liable for storm damage. This interpretation is however open to challenge: nowhere in the policy did it indicate that the posting of a watch related only to those specific risks. The example in fact illustrates the difficulty in determining when a given provision relates to a specific risk or risks and when it relates to the risk more generally.91

The Commission’s 2014 report and the Insurance Act 2015

5.33 The Commission’s reports over the period 1957 to 2012 illustrate the evolving nature of the Commission’s thinking and the difficulties in crafting a set of proposals

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that deal effectively with the range of complex issues presented by the law in this area. The Commission returned to the subject once more in 2014, with their proposals finally leading to the enactment of the Insurance Act 2015. Given their importance and the very close linkage between the Commission’s 2014 proposals and the Act, these two items are considered in and 9. However, before considering the UK reforms we will first, as a basis for comparison, critically examine reform initiatives taken in Australia and New Zealand.